Friday, October 26, 2012

Conflict of Interest - credit cards

A lot of people know of this term, yet many don't seem to really notice it happening around them. So I want to illustrate an example here, and it's quite pertinent to a lot of people of my generation.

A conflict of interest arises when a person or organization that you have trusted to behave in a certain way, have their best interests in behaving in another way that you may not be aware of.

So let me explain with an example. Credit Cards.

Imagine that you are using a credit card of a reputed bank for quite a number of your transactions. Shopping, eating out, buying stuff online, booking tickets, paying your bills, etc. The card has a generous credit limit and time of repayment; doesn't charge any interest to you when you duly pay the money that you've spent using this card.

So, you use the card, let's suppose, to do Rs.40,000 worth of shopping for a special occasion, towards the end of the month. You don't want to upset your bank balance and pay day is still a week away, so you use the credit card. Quite normal. You pay back by the due date, by which time you've received one or two paychecks.

So this is a risk-free use. You're not gambling on anything. You're a mature credit card user. And it's not like there's been a learning curve for you that you bungled up any time in the past - this is your first time using a credit card and you're already proper.

So, consider this: you're not a super-human. This much prudent use, any other credit card user like yourself can do.

You're not paying anything extra for this. No credit card usage bills, no interest, as promised.
Which means for Rs.40,000 of transactions done by you, your credit card company isn't actually making any extra money. They spend Rs.40,000 for you; you pay them back within good time. No profit, no loss.

And this normal profile applies to practically all their customers.
No profit, no loss. Everything is clean.

Then please explain to me how the heck does the credit card business make multi-billion dollar profits every year?
How the hell does one make billions out of a system that is, in its normalcy, designed to be no-profit, no-loss?

Now, I've never actually made the error of owning one, so I don't know for sure, but if I know you to be a normal human being, I don't think you'd sign up for this service if there was a very high normal fee on using this card. You must be paying either nothing or peanuts. Adding up all the users, this doesn't account for billions in profits.

If majority of the users are regular human beings and only a fraction of all users, as with car drivers, are risky ones, then automatically the number of immature users would dwindle out. (just as a risky car driver would eventually get into an accident and would not drive henceforth). So even this tiny fraction paying extra fees for missing a deadline, couldn't account for billions in profits. At best, this would happen for an initial year or two and then would fizzle out. So how can we explain sustained mega profits for this industry?

What about the businesses you've transacted with, they might be giving them a cut.. HELLO, most of these guys have to PAY some fees to have the systems connected. Many shops I've been to, charge more if you're not paying in cash. These businesses that sell us products/services would lose out on their profit margins if they were paying any big cuts to the card companies. If they tried passing the costs on to the consumer, they'd lose their customers to their competitors. And there's even lesser shops than people.. multi-billion profits off just usage fees? Sorry boss, the numbers, and the best interests, don't add up.

The answer comes when you break free from one critical assumption. The assumption is that the credit card company wants normal usage from its customers, as printed on their brochures and websites and agreements.
You see, if everyone paid all their dues on time, credit card companies would be reduced to non-profit organisations. Zero interest rates for proper repayment of dues. Zero transaction fees. Zero or peanuts in usage charges.
There is zero profit to be made if everything goes smoothly.

And that's where Conflict of Interest comes in.

Your credit card company's best interest - the source of its profits and its execs' high salaries - lies in you NOT paying your credit dues properly. They stand to benefit most when you perform worst.
So even if it's not printed on the fancy brochure, somewhere along the way, the system will deliberately try to make sure you bungle up.
There's no need for any evil motives, any top secret conspiracies for this. The system itself is designed to take you along this path, and everyone in it has to, for their own job's sake, do everything in their power to make you fail.

So take a look around you. The number of people in your generation who've defaulted on their credit card payments is vastly more than you think. They're not stupid. They're not immature that this happened with them. They're normal people just like me and you.

What happened to them wasn't an unusual aberration -- it was an inherent feature of a system that is designed to secretly work against their best interests. A credit card company's Raison D'Etre - purpose of existing, is to rip you off. Its earnings are derived from people screwing up. In the course of its operations, no matter how prim and proper its routines look, no matter how warm and welcoming its advertisements, every possibility that leads to a screw-up, will be deliberately engineered to happen. There is a total conflict of interest here.

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