Credit cards are ubiquitous in the 21st century. However, it hasn’t always been that way. In fact, credit cards have only really exploded with popularity in the past 20 to 30 years.
Today, we don’t think twice when we hand over a piece of plastic with a magnetic strip to pay for a hotel room or our groceries. We don’t give second thought when we tap a piece of plastic against another piece of plastic to make a payment.
Obviously, we’ve come a long way with the history of credit cards. Today, we’re taking a look at where credit cards came from – including the earliest credit cards, and what the credit cards of the future might look like.
1800s and the Early Beginnings of Credit Cards
The thing we know as a “credit card” is a relatively new invention. However, the concept of credit cards is over 150 years old. As far back as the late 1800s, consumers were using “credit” to pay for goods and services.
In these days, we didn’t use magnetic strips on pieces of plastic. Instead, we used things like “credit coins” and “charge plates”.
Even before the late 1800s, credit was a part of doing business for centuries.
Consider a medieval serf who goes to his local bakery to buy a loaf of bread in the year 1350. He forgot to bring his coins with him, so he tells the baker he’ll pay him the next day. The baker, knowing the man comes in every day, agrees, and the man leaves with the bread he purchased on credit. That’s “credit” in its most basic form.
With that in mind, credit cards are just a formalized version of this basic concept.
The World’s First Credit Cards
The world’s first credit cards are traced back to the early 1900s, when oil companies and department stores started to issue their own proprietary plastic cards.
These cards were small-scale at first. The cards were only accepted at store to which the card belonged. Only a small number of stores even accepted the cards. These payment systems started to appear in larger cities and were rarely seen in smaller towns.
These cards weren’t designed to lure people into spending more money than they could afford. Instead, they were designed to create customer loyalty and improve customer service.
1946 and the Charg-It Card
A card called the Charg-It is considered the world’s first bank card. It was created in 1946 by a banker in Brooklyn named John Biggins.
Customers could use the card to make a purchase. Then, the bill for that purchase was forwarded to Biggins’ bank. The bank would reimburse the merchant for the goods, and then the bank would obtain payment from the customer.
There were some big drawbacks with this card. It only worked on purchases you made locally. Additionally, you had to have an account at the one specific bank.
In 1951, New York’s Franklin National Bank issued its first bank credit card. That credit card could be used only by the bank’s account holders, similar to the Charg-It card.
The Diners Club Card
The Diners Club Card was another important step in the history of credit cards. The Diners Club Card comes with a now-famous story: its inventor, Frank McNamara, had a business dinner at a swanky restaurant in New York City. When the bill arrived, Frank embarrassingly realized he had forgotten his wallet. Although Frank managed to find a way out of the awkward situation, he realized how valuable it would be to have an alternative to cash.
Thus, in 1950, McNamara and his business partner Ralph Schneider returned to the restaurant and paid their (new) bill using a small card. It was the world’s first credit card with widespread use, and it was made of carboard – not plastic. The Diners Club Card was designed specifically for travel and entertainment purposes.
By 1951, just one year after it launched, there were 20,000 Diners Club cardholders across America. The card technically worked more like a charge card than a credit card. You purchased stuff on credit, but your bill had to be paid in full at the end of each month.
Before the 1950s was over, the Diners Club Card swapped its old cardboard design for plastic, signaling the rise of the plastic credit card.
American Express Launches a Competitor
American Express was launched all the way back in 1850, when it operated as a competitor to the United States Postal Service. In 1882, the company began to offer money orders. In 1891, American Express invented the world’s first traveler’s checks.
According to the American Express archivist, the company talked about creating a travel charge card as far back as 1946, but decided to put it on the backburner.
Then, once the Diners Club Card took off, American Express realized there was an opportunity.
In 1958, American Express launched a distinctive purple charge card that allowed cardholders to pay for travel and entertainment expenses. Like the original Diners Club Card, this card was made of cardboard. American Express would launch their plastic credit card in 1959.
American Express realized there was a market among travelers: they began to introduce local currency credit cards in other countries. Within 5 years of launching their card, American Express cards were being used by 1 million cardholders across the United States, who paid for goods and services at 85,000 different establishments – both inside and outside the United States.
American Express continued to be a travel and entertainment expenses credit card exclusively all the way up until the 1990s, when they decided to transform into an all-purpose credit card.
Closed Loop Systems in the Early Days of Credit Cards
Back in the 1950s and 1960s, credit cards used a closed loop system. This was due to technological restraints: there wasn’t a mass communication system like the internet available to process international transactions at the speed of light.
The closed loop system consisted of the consumer, the merchant, and the issuer of the card. In this system, the issuer both authorizes and handles all aspects of the transaction, then settles directly with both the consumer and the merchant.
These early charge cards had a crucial problem: they weren’t exactly credit cards. You weren’t borrowing money, and you had to pay off your card in full at the end of every month.
That’s when Diners Club and American Express cards both introduced the option of maintaining a revolving balance. That meant cardholders no longer had to pay off their bills in full at the end of each cycle. Cardholders who didn’t pay off their bill in full were subject to finance charges, but it gave them more flexibility with their money.
Later, banks would introduce the idea of paying off your balance in installments. In exchange for financing fees, you could pay back only a portion of your credit balance each month. This led to the modern system of credit financing we have today.
Bank of America and the General Purpose Credit Card
Inspired by the success of American Express, the Bank of America created the BankAmericard brand in 1966.
Today, the BankAmericard brand is known as Visa. The BankAmericard credit card was a general purpose card. To manage this card, they created an organization called the BankAmerica Service Corporation. This corporation franchised Visa to banks across America.
MasterCard is Born
MasterCard was born around this same time. The same year that Visa was created, in 1966, a national credit card system was formed when a group of credit-issuing banks joined together to create the InterBank Card Association. Today, that association is now called MasterCard Worldwide (it was also called “MasterCharge” at one point in its lifecycle).
The InterBank Card Association was designed to compete directly with Visa.
There was a key advantage that these two organizations – the InterBank Card Association and the BankAmerica Service Corporation – had over their competitors: they were open loop systems as opposed to closed loop systems.
Open Loop Versus Closed Loop Systems
The open loop system required interbank cooperation and fund transfers in order to work. Banks had to agree to transfer funds to one another by joining either organization.
Interestingly enough, Visa and MasterCard continue to use these open loop systems to this day, while American Express, Diners Club, and Discover Card are all closed loop systems.
That’s why you apply for Visa and MasterCard differently than you apply for American Express or Discover. You apply for Visa and MasterCard credit cards through your bank. Visa and MasterCard issue their credit cards through member banks, although both still set and maintain the processing rules.
Banks had to make a choice: they could choose to offer either Visa or MasterCard to their customers. Members of either organization shared card program costs, which is why even smaller banks could offer Visa and MasterCard to their customers.
Over time, banks realized it was dumb to offer only MasterCard or Visa to their customers. Both associations changed their bylaws, allowing banks to join both associations while offering both Visa and MasterCard to their customers.
Over time, Visa and MasterCard were responsible for some of the biggest innovations in credit card processing systems. They frequently invested in processing technologies that made credit card transactions more efficient.
American Express Branches Out
Starting in 1987, American Express stopped being a credit card exclusively for travel and entertainment expenses, and they started being a credit card for general purpose expenses. Today, America Express continues to offer a wide variety of credit cards while still maintaining its original profitable travel and entertainment cards catered to the corporate market.
Sears Introduces the Discover Card
Sears Corporation introduced the Discover Card at the 1986 Super Bowl. Discover saw an opportunity to create a new brand in the thriving credit card industry. They wanted to create a brand with its own merchant network – and merchants liked the sound of it.
2004 and a New Era of Credit Card Competition
Still, over the 1990s and early 2000s, Visa and MasterCard continued to dominate the market, making it difficult for new competitors to break in. In 2004, the US government and the Department of Justice initiated an antitrust court ruling that altered the exclusive relationship between Visa, MasterCard, and America’s banks.
After 2004, it became easier to compete with Visa and MasterCard, which is why we’ve seen a resurgence in growth for American Express and Discover, among other cards.
Reward Programs Lure in New Customers
Today, we take it for granted that you’re rewarded – in some way – for using your credit card. Points cards and cashback cards are particularly popular.
These rewards cards can be traced back to 1989, when Citibank signed a deal with American Airlines to give cardholders reward points. They didn’t know it at the time, but it was a turning point in the credit card industry.
This change led to a surge of people not only receiving new credit cards, but actually using them for ordinary purchases. Now, customers had an incentive to leave their cash at home while paying for everything with credit cards.
The Removal of Fees
Credit cards went through a period in the 1980s were profitability was low. Consumers weren’t spending as much money, and the cost of lending out money was high.
Banks needed to find a way to attract their best moneymakers: people who carry a balance on their credit cards from month-to-month, giving banks their coveted 18 to 30% interest rates.
Banks realized that annual fees were holding people back from getting credit cards. However, fees weren’t considered a mainstay of the business: banks made most of their profit from lending out money. Thus, banks started to remove fees from credit cards. Banks offered teaser interest rates of 0% for balance transfers, and most banks removed their annual fees completely.
Credit Card Processing Technology in the 1990s
Starting in the 1970s, credit card processing technology has improved by leaps and bounds on a regular basis. The rise of global communication systems was changing credit card processing technology long before the internet was invented.
Today, financial institutions charge credit card fees called “interchange fees”. These fees are controversial – Visa has raised its interchange fees by 117% in the last 5 years alone. Ultimately, it means financial institutions make about 2% from each credit card transaction. However, banks also make money through annual fees, late payment fees, outstanding balances, and more.
Modern Credit Cards
Over the past few decades, credit card technology hasn’t changed as much as you might think. Credit cards were already relying on electronic credit card processing back in the 1970s, so the internet didn’t change the credit card industry as much as it changed other industries – the credit card industry had already changed before the internet came about!
In any case, modern credit cards use the same magnetic strip they’ve used in the past. Over the past decade, however, credit card companies have added chip technology and tap-to-pay technology that makes them easier to use than ever before.
What Does the Future Hold for Credit Cards?
One theme has remained common throughout the history of credit cards: credit card companies really want you to spend money. Their goal is to get you to spend as much money as possible, and then they make money off of the high interest rates and financing fees. That’s what their business is based on.
All of the technological improvements that have taken place over the years have revolved around making it easier to spend money – from the early days of the Diners Club card to modern Visa and MasterCard technologies. That theme isn’t going to change as credit cards enter the future.