Do Banks Make More Money from Credit Cards or Standard Loans and Mortgages?

When comparing the profitability of credit cards and traditional loans such as mortgages, it is essential to consider the differences in revenue sources, the nature of the loans, and their respective volumes. Banks tend to make more money from standard loans such as mortgages due to the sheer volume of these transactions and their longer tenors, even though the return on individual credit card transactions may be higher.

The Value of Credit Cards vs. Standard Loans

From an ROI perspective, credit cards are significantly more valuable for banks. Credit card interest rates often range from 15% to 20%, which is quite high compared to standard loan interest rates. However, a substantial proportion of a bank's loan portfolio consists of secured loans, overdrafts, and mortgages. Due to the large volume of these transactions, the total earnings from these types of loans can surpass those from credit cards.

The Australian Perspective

In Australian banking, the situation is no different. Mortgage margins are tight, which indicates that the competition among banks is intense. Many products, including credit cards, come with an annual fee as part of a complete banking package. Credit cards, while offering a high return on investment, often have a minimum credit balance requirement with points tied to the hope that consumers cannot repay the balance, thereby incurring the high-interest rates.

ROI Comparison of Credit Cards and Loans

While credit cards can offer a high monthly return, such as 3.46% per month, which amounts to over 36% per year, the actual profit from individual credit card transactions is offset by the high interest rates. On the other hand, unsecured loans like credit cards and personal loans, despite having a higher return on investment, typically rely on smaller ticket sizes and higher carrying costs.

The Business Model of Banks

Banks generate more revenue from secured loans, particularly mortgages, because they have a wider market spread and are more prevalent in the overall portfolio. Fully 80% or more of a bank's loan portfolio consists of secured loans due to their lower default risk and higher loan sizes. Conversely, unsecured loans, like credit cards, are a smaller segment, typically making up only 20% of a bank's total loans. Due to the higher risk of unsecured loans, such as the risk of non-repayment, banks tend to charge higher interest rates to offset potential losses.

Mortgage Interest Income and Fees

It is pertinent to note that banks also generate significant interest income from mortgages, which are secured by real property. Additionally, banks earn fee income from originating loans for both purchasing and refinancing homes. These fees contribute to the overall profitability of mortgage loans.

Conclusion

While credit cards can offer a higher return on investment, the sheer volume and longer-term nature of secured loans such as mortgages result in higher overall revenue for banks. Understanding the business model and nuances of each loan type is essential for a comprehensive analysis of which is more profitable for banks.