It started with dinner: How the first credit card came to be and how credit cards have evolved
It started with dinner: How the first credit card came to be and how credit cards have evolved
Issue 1 | 18 September 2023
The first credit card
The introduction of the first credit card came about with the Diner’s Club International in 1949. The story goes that Frank McNamara was out to dinner with his wife and clients, when we realized that he had forgotten his wallet. His wife had to pay for his meal (the horror!), so he decided to create a multi-purpose charge card to avoid future embarrassments. He approached the restaurant owner, and then later returned to the same restaurant and paid for his meal using a cardboard charge card and his signature. The story is apocryphal, but Frank McNamara’s idea to create a modern-day charge card was not.
Thus, the first charge card emerged. It caught on quickly - within the first year, the card has 10,000 users, 28 participating restaurants and 2 hotels. However, it wasn’t a traditional credit card (as we known credit cards today) as the balance had to be paid off at the end of the month.
How do credit cards transaction work
Today, credit cards are typically managed by card schemes or card networks (e.g., Visa, Mastercard, Discover, American Express) that are linked to payment cards and help facilitate card transactions. The card schemes (or networks) typically set the rules for the network and act as a routing switch between the issuer (cardholder’s bank) and the acquirer (merchant’s bank). In fact, the most commonly used card scheme is the Four Corner model (Four Party) where the card networks provide interconnectivity and communication between four entities:
(1) Cardholder, (2) Issuer (Cardholder’s bank), (3) Merchant and (4) Acquirer (Merchant’s bank).
Most of the steps shown in this model take place pretty quickly (within a few seconds). However, there is a final step (step 9) that takes a little while - this is the settlement between the issuer and the acquirer. Typically, merchant will batch their transactions from their point-of-sale terminal, and send it to the card networks, who then match the transactions with the issuer and sends the transactions to them. The issuer will charge the cardholder’s account (or the transaction will show up on the cardholder’s statement). The issuer will send the funds to the acquirer minus any interchange fees (fees paid to the card networks).
That is why some credit card transactions will show up as pending on your account, as the merchant hasn’t sent over the transactions to the card network for settlement, even if the transaction has been authorized.
The evolution of credit cards
The Four Party model is well established and US consumers continue to show a strong preference for credits cards over other payment methods with 532 M active credit cards in the US (Q1 2023). This preference is due to a combination of rewards, discounts and other offers as well as the ability to pay for expenses over time.
As technology continues to evolve and digital payments gain traction, credit card technology has also evolved to make the transactions more convenient and secure. Credit card innovations have particularly accelerated in the last 20 years: from the introduction of Chip and PIN technology for added security to the use of Near Field Communication (NFC) to drive contactless payments to the proliferation of digital wallets.
The staying power of credit cards
As technology continues to progress and digital wallets become more commonplace, it doesn’t seem like US consumers want to give up their credit cards. Merchants on the other hand, would prefer not to pay the card network fees (known as interchange fees), which ranges from 1.15% to 3.25% of the transaction depending on the card network.
As a result, certain large retailers offer in-store incentives for customers who use the store’s debit card. For example, Walmart has introduced the ONE debit card which offers 3% cash back at Walmart. Target’s RedCard can be linked to the customer’s bank account and offers a 5% discount on purchases and free 2-day shipping. Since the fees on debit cards are limited to 0.05% of the transaction (no fee limits on credit cards currently), it is much more economical for merchants to process payments via debit cards even if the underlying card networks that processes the payments are the same.
In addition, merchants can work with companies like Catch, Trustly, and GoCardless to offer pay-by-bank payments for their customers. Pay-by-bank payments are taken directly from the consumer’s checking account and doesn’t require the use of a debit or credit card, allowing the merchant to save on fees. Companies like Catch and Trustly offers incentives such as discounts on every transaction to drive volume.
However, it remains to be seen if these alternative payment methods will gain traction with consumers, or credit cards will still be the preferred payment method in the future.