The truth about chip cards

Over the next three years Canada’s major credit card issuers plan to move from familiar magnetic stripe cards using customers’ signatures for authentication to cards with a built-in microprocessor that checks a personal identification number (PIN) that the cardholder enters on a point-of-sale device when making a purchase.

A new study commissioned by Visa Canada claims the move is necessary because of rising credit-card fraud and the benefits will justify the costs to retailers. A national retailers’ organization, however, says the study doesn’t change its concerns about costs.

The chip cards – often called smart cards – should go a long way toward combating several common types of credit-card fraud, said William Giles, vice-president of advanced payments at MasterCard Canada. They will be harder to duplicate than magnetic-stripe cards, and the use of PINs will reduce fraudulent transactions with lost or stolen cards and new cards intercepted on their way to the cardholder, he said.

The study, commissioned by Visa Canada and conducted by J.C. Williams Group Ltd., a Toronto retail and marketing consultancy, said credit card fraud in the United Kingdom dropped by 65.4 million pounds (about $151.9 million) from 2004 to 2005 when chip and PIN technology was introduced there.

The J. C. Williams study also noted, though, that fraudulent transactions involving online and phone purchases – known in the business as card-not-present transactions – increased in Britain after the switch. Realizing that some avenues had been closed off, the study concludes, fraudsters switched to other approaches. The study also says fraud involving the interception of new cards increased temporarily, though it later dropped to below previous levels.

“Our understanding is that card not present fraud has continued to grow and has grown substantially,” said Peter Woolford, vice-president of policy development research at the Retail Council of Canada in Toronto.

The initial form of chip and PIN technology won’t help stop fraudulent card-not-present transactions, admitted Allen Wright, director of chip initiatives at Visa Canada. But he said Visa is working on other measures to combat it, such as its existing Verified by Visa password plan and new technology that could generate a verification code to be used in phone and online purchases.

Giles said a device that will read a chip card and display an eight-digit verification code could be the answer to card-not-present fraud. Costing around $10, the reader would be cheap enough for consumers to buy or credit-card issuers to supply to their customers free. When ordering online or by phone, you would slide your card into the device and enter your PIN on its keypad. The device would then generate a one-time code that you would type into the web site or read to an operator over the phone.

Giles said this technology has worked in Britain and will likely be rolled out alongside chip and PIN cards in Canada.

For most merchants, adopting chip and PIN technology will mean replacing existing card-reading equipment with new devices that the J.C. Williams study said will cost about $200 each.

The study said most small businesses rent these devices and will face little or no cost when they are replaced.

Cost concerns are more significant for larger retailers who maintain their own integrated point-of-sale systems. They may need to modify these to deal with the new cards. Citing an interview with an unnamed point-of-sale software developer, the Williams study said experts estimate the cost could run between $20,000 and $35,000.

While not disputing the study’s claim that cost to small retailers will be minimal, Woolford is doubtful about its estimates on costs to larger organizations. “Just talking with our members, our sense is that those numbers are probably a little optimistic,” he said. Indeed the Williams study also noted that one large British retailer, Tesco, estimated its conversion costs at 1.5 million pounds (about $3.5 million).

Giles also noted that costs will be higher for some retailers, such as gas station operators who will have to replace pay-at-the-pump hardware that in most cases is quite new.

Reduced fraud is the major benefit expected from the new cards. The J.C. Williams study said one industry expert – not named – estimates it will reduce over-all chargebacks to retailers by one fifth of one per cent. The technology will also help alleviate consumer concerns about credit-card fraud, the study said.

The study also argues that using PINs instead of signatures could speed up transactions, and will eliminate the need for stores to keep stocks of duplicate receipts for credit-card transactions.

Woolford said the Retail Council believes the study’s estimated benefits are “a little optimistic.”

Lisa Hutcheson, senior consultant at the J.C. Williams Group, said cost and benefit estimates were based on the U.K. experience and discussions with industry experts and retailers, and “we do feel very confident in the numbers.”

Giles said MasterCard will not insist that any retailer install new hardware, and will be issuing cards with magnetic stripes as well as chips for some time. Visa, on the other hand, has said that as of 2010 merchants who have not updated their card-reading hardware will be liable for fraudulent transactions.

The two card issuers and the Interac Association, which administers the nationwide automated teller machine and debit card network, plan a joint technology trial in the Kitchener-Waterloo area starting this fall. Visa and MasterCard both plan to start distributing chip cards soon after the trial is done. Wright said 92 per cent of Visa cards will use chip and PIN technology by the end of 2010.

Besides Britain, Hutcheson said, France and a number of Asian and African countries have already adopted chip and PIN cards. J.C. Williams focused on the U.K. experience because the market there is the most similar to Canada and because the implementation was recent, she said.

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Grant Buckler
Grant Buckler
Freelance journalist specializing in information technology, telecommunications, energy & clean tech. Theatre-lover & trainee hobby farmer.

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