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How can banks afford to offer credit card rewards?
There are 3 entities in a credit card transaction; Typically when you swipe for 100, the merchant only gets around 97.5. The 2.5 is divided amongst the 3 entities, roughly around 0.5 for the Merchant Bank, around 0.5 for the Card Network and a lions share to Issuing Bank of around 1.5 The reason Issuing Bank gets large share is because they take the risk and provide the credit to customer. Typically the Issuing Bank would pay the Merchant bank via the Card Network the money in couple of days. So the Merchant Bank is not out of funds. The Issuing Bank on the other hand would have given you a credit of say 10 to 50 days depending on when you made the transaction and when the payment is due. On an average 30 days of credit. So roughly the Acquiring Bank is lending money at the rate of 18%. It is from this money the Issuing Bank would give out rewards, which is typically less than 1%. Also in cases where say Merchant Bank and the Issuing Bank are same, Bank would make money on both the legs of transaction and hence launch co-branded cards with better rewards. The above numbers are illustrative and actual practices vary from Bank to Bank to card Network to Country Related question at How do credit card companies make profit?