Monday, November 3, 2008

A Brief History of Credit Cards

Credit cards, as we know them today, have been around for just over half of a century. One of the first credit cards appeared in 1951 when loan customers of Franklin National Bank of New York were screened for credit and those approved were given a card they could use to make retail purchases. Participating merchants copied the customer information from the card onto a sales slip and the bank would credit the merchant account for the loan less a flat fee to cover the costs of providing the loan. In 1958, The American Express Company (a company built on the traveler's cheque business) began issuing a charge card for travel and entertainment charges which was accepted at participating restaurant, hotel and airline merchants.

Cardholders enjoyed the convenience of plastic charge cards (especially when on the road for business) as well as the line of credit offered by the new bank credit cards. Merchants found that credit card customers usually spent more than if they had to pay with cash (which is still true today – the average credit card purchase is 112% more than if cash is used). Accepting bank-issued cards was safer for the merchant than dealing with cash (more secure from internal and external theft and error) and less expensive than creating and maintaining a merchant-specific credit program.

Bankcard Associations
In 1959, Bank of America began issuing the BankAmericard within California, which was the first universal credit card with widespread merchant acceptance. Bank card associations began in 1966 when Bank of America formed licensing agreements with other banks. This enabled them to issue credit cards on a widespread basis and settle transactions among participating banks.

Also in 1966, a group of 14 US banks formed Interlink, a new bankcard processing association with the ability to exchange information on credit card transactions. In 1967, four California banks formed the Western States Bankcard Association and introduced the MasterCharge program (which was later renamed MasterCard in 1979) to compete with the BankAmericard (later renamed Visa in 1976) program. VISA and MasterCard are organizations that both issue credit cards through member banks and set and maintain the rules for processing. They are both run by board members who are mostly high-level executives from their member banking organizations.

As the bankcard industry grew, banks interested in issuing cards became members of either the Visa Association or MasterCard Association. Their members shared card program costs, making the bankcard program available to even small financial institutions. Later, changes to the Association bylaws allowed banks to belong to both Associations and issue both types of cards to their customers.

Credit Card Processing Evolves
As credit card processing became more complicated, outside service companies began to sell processing services to VISA and MasterCard association members. This reduced the cost of programs for banks to issue cards, pay merchants and settle accounts with cardholders, thus allowing greater expansion of the payments industry.

Visa and MasterCard developed rules and standardized procedures for handling the bankcard paper flow in order to reduce fraud and misuse of cards. The two associations also created international processing systems to handle the exchange of money and information and established an arbitration procedure to settle disputes between members.

Other Issuers Join the PartyAs mentioned earlier, American Express was among the first companies to issue a charge card. However, it waited until 1987 before issuing a credit card that allowed customers to pay over time. Their original business model focused on the travel and entertainment charges made by business people, which involved significant revenue from merchants and annual membership fees from customers. While these products are still in their tool chest, they have also developed numerous no-annual fee credit card products offering the same low introductory rates and reward programs as traditional bank cards.

Another relatively recent entry into the card business is Discover Card, originally part of the Sears Corporation. Discover Card Services sought to create a new brand with its own merchant network. The company has been quite successful at developing merchant acceptance, surpassing even Visa in worldwide acceptance locations. A 2004 antitrust court ruling against Visa and MasterCard initiated by American Express, Discover and retailing giant Walmart have changed the exclusive relationship that Visa and MasterCard have enjoyed with Banks. Going forward banks and other credit card issuers will be able to provide customers with an American Express or Discover Card in addition to a Visa or MasterCard. While the bankcard associations have dominated the card business in the past several decades the tide may be turning with the new court rulings.

The credit card has evolved significantly in the past half century and will continue to change with technology as new frontiers in payments develop. What will the payments landscape look like in another 50 years? Only time will tell.

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