Making the Cost of Chip Cards Fit the Crime

NEW YORK (TheStreet) -- Visa (V) and MasterCard (MA) are pounding the table on the "liability shift" scheduled for October 2015. That's when responsibility for losses on credit card transactions moves, or shifts, from card holders to merchants.

Right now cardholder banks mostly eat these losses, which are estimated at a whopping $5 billion per year. After October 2015 this will start to shift to merchants' banks, and thus to merchants.

If a customer offers a chip-embedded card (as opposed to the current cards with a magnetic stripe on the back) after that date and the merchant doesn't use a chip reader, the merchant could be liable for any fraud that results. The money would come out in the "discount" processors charge for their service, currently about 2.25%. 

Sounds terrible, until you realize U.S. bank card transactions total $4.4 trillion per year.  That makes $5 billion a rounding error.

Chip cards cut the most common fraud -- counterfeit cards created with data stolen from merchants, as in the Target (TGT) breach last Christmas.  European merchants, who process transactions in batches and adopted chip cards years ago, see very little fraud from counterfeit cards.

If all merchants adopt both chip cards and the use of PIN numbers (rather than signatures) in transactions, it would reduce losses from lost and stolen cards. But this is the least-common type of loss.

The fastest-growing form of card fraud, the use of stolen account numbers in online transactions, is not addressed by chip cards, even with a PIN. Small merchants without online stores wonder, why worry?

There are three main components in any card transaction. Acquirers, who work on behalf of merchants, running the transaction and moving the money, are ready for the shift, said Ellen Richey, chief enterprise risk officer at Visa.

Issuing banks, the banks that hand out credit and debit cards, will start shipping chip cards over the next year as cards expire. They will mostly be ready for the liability shift.

The problem is with retailers, most of whom have yet to buy the new terminals and electronic cash registers required to handle chip cards, also known as EMV cards because Europay, MasterCard and Visa cooperated on the specifications.

The fix is expensive. It can cost $1 to $2 to make a chip card against 10 cents for a magnetic stripe. The difference in cost is narrowed in practice, Richey said -- both take the same amount of money to ship -- but it's still real.

The Nilson Report estimates there are 1,096 million credit and debit cards in circulation. A $110 million bill is about to become a $1.1 billion to $2.2 billion bill.

The same differences apply to terminals. Companies like Square give away mag-stripe terminals in order to get merchant business -- they cost just $10 to produce. A terminal that takes chip cards may cost $100. Cash registers also need to be updated, and employees have to be trained.

Jason Oxman, head of the Electronic Transaction Association (ETA), is leading the charge to have merchants spend the money. He has his work cut out for him.

"Two-thirds of the nation's merchants don't have a pin pad as part of their card acceptance," he explained. "It's also a change in the checkout." Already a lot of fast-food merchants don't even process small transactions or require signatures on small purchases. "For a small ticket you're willing to accept more fraud risk," he added.

Even if merchants buy chip terminals and banks issue chip cards, it won't deal with the fastest-rising fraud problem in the business, which is online fraud.

A Lexis-Nexis study released last September found merchants actually lose $3.10 for each $1 in online fraud losses. Cybersource, a unit of Visa, said in its latest report that online fraud costs merchants $3.5 billion in 2012, but that was less than 1% of online revenue.

There are solutions coming for online merchants, said Richey. Encrypting data can protect customer records and transaction data. Tokenization, in which a one-time token stands in for customer data, will also help. A  standard for that from Visa and MasterCard is now before EMVco, which created the chip and pin standard.

Staying ahead of the robbers is an arms race, and it's a race that can be won. The problem is making the cost of the fix worth it.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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