One of the most ubiquitous forms of payment today is credit cards. The odds are good that you have one, and most probably have one on your person right now.
But how did it come about that you could pay for something by just giving someone a piece of plastic and who exactly came up with this idea?
Learn more about credit cards, where they came from and how they work, on this episode of Everything Everywhere Daily.
This episode is sponsored by the Tourist office of Spain.
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Once again, that is Spain.info.
As with most everything I talk about on this show, the idea of credit has a very long history. The Code of Hammurabi, one of the oldest systems of laws in the world, has sections on how to deal with credit. It put maximum interest rates on loans of grain and silver.
Credit was something that was usually done on a very personal basis. The ability to extend credit to someone was dependent on your relationship with them and your trust in them.
In fact, the word credit comes from Middle French and it was originally used to mean “belief or faith”. If you extended credit to someone, it was literally a belief in the ability of that person to pay you back.
This is the way credit worked for centuries. An individual store would extend credit to individual customers based on their relationship and trust.
This sort of system still might exist in someplace like a pub or a bar where a regular might have a tab that they pay at the end of the month.
This system of individual lines of credit being established for individual customers by individual businesses was very inefficient.
The process of making credit more efficient was begun in the late 19th and early 20th centuries with major department stores like Macy’s and Wanamaker’s.
Their wealthiest customers didn’t want to handle money directly, so they were given paper cards or brass tokens they could present at checkout. The cashier would then make note of the purchases, and the customer would then get a statement at the end of the month.
This form of credit wasn’t intended to be a loan like many credit cards today are. The amount had to be paid in full at the end of every month.
What this system had over previous systems, is that the individual cashier didn’t have to know the person who presented the token. The store would issue the token, and any employee could then accept it.
In 1935, the Charga-Plate system was unveiled by the Charga-Plate Group out of New York. It was a rectangular metallic plate that was about the size of a dog tag. Like a dog tag, it has embossed letters showing the name and address of the customer.
In most cases, the metal plates were kept at the store rather than in the hands of the customer. They were then pulled out when the customer made a purchase.
This certainly made processing paperwork easier, and again it was an advance, but this system still only worked at single stores.
Another innovation came from the Air Transport Association which issued the Air Travel Card in 1935. The card had a unique number associated with each account, not just a name and an address.
The card was first issued by American Airlines, but by 1945, it was adopted by 17 different airlines. Moreover, they began allowing people to purchase tickets on installment.
Eventually, the Air Travel Card became used universally and the card is still in use today.
There were still major limitations, however. While the Air Travel Card could be used at multiple airlines, that is all it could be used for.
The thing which was needed was a card which could be used anywhere. Something which could be accepted by any merchant.
The inspiration for this occurred in 1949 in New York. Frank McNamara was having dinner at the Majors Cabin Grill where he was entertaining clients. He had forgotten his wallet, so his wife paid the bill.
He thought that a multipurpose charge card that would be accepted at any merchant, would solve this problem. He talked about it with the restaurant owner and with his lawyer, Ralph Schneider.
McNamara and Schneider got to work developing such a card, and one year later they had another meal at the Majors Cabin Grill and this time paid for it with a paper card and a signature. This became known as “The First Supper” and it was the beginning of the first multipurpose card: Diners Club.
The initial idea for Diners Club was that it would be used in restaurants in New York, but the idea quickly expanded to other businesses.
The card was not a credit card per se, but a charge card. The difference is that a charge card has to be paid in full at the end of each month.
The business model for Diners Club was to charge cardholders $5 per year and charge merchants a 7% fee.
In 1958, American Express, a 100-year-old company that was in the business of issuing money orders and traveler’s checks, offered their own card. It was so popular that a quarter-million cards were requested before the card actually launched.
Like Diners Club, the American Express card was initially just a charge card and did not have a revolving line of credit.
Both American Express and Diners Club were basically in the business of payment processing. They weren’t banks and weren’t in the business of giving loans.
The first bank to issue a payment card tied to a line of credit was the Franklin National Bank in Long Island, New York. In 1951 they allowed cardholders to pay the entire bill at the end of the month, or they could pay interest on the outstanding balance if they choose to do so.
The card was extremely popular and within a year it had 28,000 customers and 750 businesses signed up.
But, it could only be used locally. The card wasn’t of any good if you left Long Island.
This final step in the creation of a modern credit card, tying a card to a revolving line of credit that could be widely accepted, was taken by Bank American in 1958. They issued what they called BankAmericard.
They picked Fresno, California as the city they would launch the card because 60% of the residents in the city were customers.
They basically gave cards to anyone and everyone. They even gave cards to people who didn’t even sign up for one. There were no credit checks because there was no way to do credit checks.
They quickly had 2,000,000 cardholders and 20,000 businesses signed up. But they quickly discovered the drawbacks of such a card. They had enormously high rates of delinquency. In the first year, rates of non-payment were 22%.
The launch was pretty much a disaster, but they were profitable by 1961. They never released the fact that they quickly became profitable so they would keep competitors away.
Despite the early problems, they did manage to solve the problem that so many cards faced. Cardholders didn’t want to pay for a card that merchants didn’t accept, and merchants didn’t want to accept a card that people didn’t use.
They began licensing the card to different banks around the country. In 1976, they eventually consolidated all of the BankAmericacard licensees under a single brand they called Visa.
In 1966, competing banks created a card known as Master Charge which was later merged with the card issued by Citibank. The Master Charge system was later renamed MasterCard, which is one of the largest card systems in the world today.
As the credit card industry matured, legislation went along with it. In 1970 legislation was passed which prevented banks from just sending out cards to people who didn’t apply. They could only send out applications from that point forward.
Much of the advancement in the technology of credit cards was designed to cut down on delinquent payments.
Originally, cards were processed by taking a physical paper imprint of the embossed card. The paper would be processed, but at the point of purchase, there was no way to verify if the cardholder actually had a valid line of credit.
Because there was no credit check, credit card fraud was rampant.
In the 1980s, cards began being shipped with a magnetic stripe on the back. This could be used with processing machines at the retailer which would verify if the credit card was valid.
Today this is usually performed by a chip embedded in the card. The chips are called EMV chips and the EMV stands for EuroPay, Mastercard, and Visa.
MasterCard just announced that they will be completely phasing out magnetic stripes in their cards in 2024.
Even if credit card companies could verify a card for a given transaction, they still had no real way to validate if someone should be extended credit. In 1989 the FICO score was developed, which allowed credit issuing agencies to know someone’s credit history.
FICO stands for Fair Isaac Corporation which was the company that developed the system. The subject of credit scores is probably worthy of an entire episode of its own.
Today, the Visa system alone processes 150 million transactions per day and they have the capability to handle many more times that number.
Credit card networks like Visa and MasterCard also now handle debit card transactions, which are linked to bank accounts, as well as ATM networks, making cards to be all-purpose financial instruments.
The next frontier is credit cards on smartphones. Systems such as Apple Pay and Google Pay allow for cards to processed on their phones. Smartphones allowed for increased security as they don’t expose credit card numbers and they can use biometric security such as fingerprint or facial recognition.
Smartphones use what’s called Near Field Communication to communicate with a card reader, which is why you don’t have to swipe or insert anything.
One of the incentives for credit cards has been frequent flyer programs. The first frequent flyer program was created in 1981 by American Airlines.
The first program to be tied to a credit card was in 1987. Continental and Eastern Airlines teamed up with Marine Midland Bank to issue the Continental TravelBank Gold MasterCard.
Today, 191 million people in just the United States alone, have credit cards. They have a total of $820 billion in outstanding credit card debt, which is actually down substantially since the start of the pandemic. Likewise, credit card default rates in the first quarter of 2021 were the lowest they have been in over 30 years at 1.87%.
Thanks to credit cards, today you can travel to almost every country on Earth and pay for goods and services in almost any currency. So long as you use them responsibly, they can be an incredibly handy way to manage your purchases.