Americans who are lucky enough to travel abroad this coming holiday season may find that their credit cards are refused by the merchant. According to a study by Aite Group LLC (based in Boston), nearly half of American cardholders who traveled abroad over the past four years ran into obstacles trying to use their credit cards. It had nothing to do with whether their personal credit was good; it was the fact that their cards still carry the magnetic stripe on the back.
The United States is the only major economy that still clings to the magnetic stripe credit card as its major vehicle for payments, as it is left behind by more secure systems like the EMV card. Banks and merchants in Central and Western Europe, the Middle East, and the Asia-Pacific region have all switched over to the EMV system, on the grounds that the mag-stripe cards are more prone to fraud.
This is sure to frustrate American shoppers who happen to travel abroad this coming holiday season. By the same token, it also impacts foreign shoppers who come to the U.S. expecting to do their holiday shopping, but find merchants unable to process their EMV-ready credit cards.
Over five million Americans affected by this situation in 2008 would have spent an average of $712 more if merchants had accepted their cards. They were forced to use cash in their pockets or walk away. Card issuers and clearing houses both lose out on revenues under this scenario.
Credit card carriers suffer a $8.6 billion dollar loss due to fraud, out of tens of billions in total chargeoffs in 2008. Yet American merchants and banks, on the whole, have dragged their heels when it came to converting to a system that really puts a bite into fraudulent in-person transactions. Why is that? And who is profiting from continuing this state of affairs?
EMV standards are 15 years old, and to judge by how quickly other technologies have been adopted at the consumer level, it should have become standard by now. (I am thinking of items like the Wii, the iPhone, or even GPS.) There are four main obstacles to the transition to the EMV format: the fragmentation of the American card market, the soft economy, the cost to merchants, and fear of the unknown.
While Canada has only a handful of national banks, making it much simpler to get everyone on board for the transition, there are thousands of banks in the U.S. that issue a credit card of some kind. Also, in the United Kingdom, the banks own the terminals, making it much simpler to upgrade the point-of-service equipment.
The global recession has slowed implementation, and yet the United States is the only major economy that has not moved forward with this technology. So it is admittedly difficult to accept this excuse for the delay.
And what is the total bill for this changeover going to be? Experts estimate that the total cost of implementation could run as high as $12.7 billion dollars. The main problem is that much of that cost is borne by retailers rather than the issuing banks. Retailers can pay $500 per checkout lane to upgrade, at minimum. Issuers can offer a discount to merchants as an incentive to change over, but even so, resistance is there.
The cost per card, though, is coming down rapidly. The cost of EMV cards has dropped to as little as $1 each, if purchased in bundles of 10,00 or more. It used to coast as much as $2.50 apiece. Mag-stripe cards cost the issuer only about 75 cents each.
Other types of retail operations may never get on board, but they are businesses that rely more heavily on cash transactions. These include gas stations, convenience stores, and vending machine operators.
The real obstacle, I’m afraid, is just pure inertia and fear of the unknown. The banks know that out of the thousands of new cards issued each year, that a given percentage will be bad accounts. And yet they are addicted to this business model. They seem to feel that the measures they have in place to manage risk are adequate, or at least familiar. The EMV system, does shift liability for transactions from the merchant to the issuer. Perhaps banks just don’t want to take responsibility for their actions?
Large international merchants are coming out in favor of chip-and-pin in the United States because it would not only create a uniform payment system, it also reduces losses due to fraud. And in this corner, stands the 800-pound gorilla, Wal-Mart, who is the world’s largest retailer. Wal-Mart reports that it has already upgraded its point-of-sale equipment to read EMV cards; just add software and Go. Home Depot and Best Buy are also in the process of equipping their stores with upgraded terminals.
So far just one issuer has come forth. United Nations Credit Union has become the first American financial institution to issue EMV-enabled cards. It plans to start rolling out the EMV debit card early next year. And terminal manufacturers have gotten into the act, too. EMV card readers are a standard feature on some hardware offered for sale.
The heaviest of the heavyweights to go to work on behalf of EMV is the Federal Reserve. Under a provision of the Dodd-Frank Wall Street Reform Act of 2010 (signed into law in July and will take effect next year), the Fed will have an actual job. (That was a bit of finance humor, ahem.) The Fed now has the authority to regulate debit card interchange for banks exceeding $10 billion in assets; it allows the Fed to raise interchange for issuers that can demonstrate an investment in fraud-prevention systems. EMV fits the bill admirably.
It might benefit those following the issue to track remarks made by Richard Oliver, who writes a frequent blog on these issues for bankinfosecurity.com He has had several positions with the Federal Reserve, and is now an executive vice president. We may see more contactless payments using a form of EMV. He was quoted in a recent article on BankInfoSecurity.com on this issue:
“Through my group called the Retail Payments Risk Forum and the Federal Reserve Bank of Boston have joined hands here to facilitate discussions on the issue of mobile in the United States. We’ve created an industry working group that’s representative of the various players in the mobile ecosystem. We met three times this year and again in October. And what we’re trying to do is help facilitate discussions amongst all the players to determine where mobile fits in to the U.S. payments landscape and how would it be justified. Is there a business case? And, basically, how might it best operate to meet the needs of all parties? When we started those discussions, I think I didn’t understand that there was much of a tie between mobile and the issues of mag-stripe and EMV chip and PIN. Now, I believe that there is a tie. I certainly believe there is a tie between EMV chip and PIN and mobile, simply because of the technologies involved.”
HOW DO THE EMV CARDS WORK?
EMV cards enable a two-tiered authentication process. The card contains a computer chip which validates the card itself and the cardholder. When inserted into a merchant’s POS terminal, the microprocessor in the card validates the chip with an algorithmic code. Then the cardholder validates himself by entering a PIN number.
TYPES OF FRAUD
The Aite Group has estimated that implementing EMV reduces two types of fraud by 90 percent or more. Counterfeiting is reduced about 90 percent, and and fraud due to lost or stolen cards is reduced 95 percent. This adds up to about 30 percent of total card fraud, so it is a substantial dent in losses. These are transactions where the card is present. With card not present transactions, EMV technology has no direct effect. This is because the consumer himself manually enters the account number, expiration date, etc for a typical online purchase. So EMV has no direct action to reduce card-not present frauds. Fraud therefore tends to migrate to card-not-present mode, so that is the next frontier in card security. This could be combated by selling portable PIN pads that could be attached to the personal computer, smart phone, or tablet computer.
The United Kingdom has completely its changeover, and Australia is going through that process now. Few countries publish their fraud stats, but Australia reports that skimming fraud on Australian-issued credit card has already fallen by one-fourth.
THE BOTTOM LINE
The bottom line is that combating fraud is the best strategy for increasing profits. And the sad truth is that if the U.S. does not implement the EMV technology, then it will become even more of a magnet for fraudsters. Richard Oliver states that “The longer the U.S. holds out on adopting EMV, the more perilous its situation becomes regarding the risk of fraud because indications are when a country adopts EMV, card fraud in that country shifts in part to countries that don’t support EMV.”
Brunswick, Steve, Australia’s EMV roll out bites into card fraud, Finextra.com, June 18, 2010, www.finextra.com/community/fullblog.aspx?id=4174
Lucas, Peter, How Soon ’til United States of Chip-and-Pin?, Digital Transactions, October 2010.
Mott, Steve, Why Smart Cards Are Coming to America, Digital Transactions, October 2010.
Oliver, Richard and Kitten, Tracy, EMV, Chip & Pin, Contactless Payments, Bank Information Security articles, www.bankinfosecurity.com/articles.php?art_id=3065