Credit cards: set to get a lot smarter?
Credit cards rely on old, fraud-prone system in the US. But Visa moves could be tipping point to turn credit cards into smart cards.
The next time you swipe your credit card at check-out, consider this: It's a ritual the rest of the world deems outdated and unsafe.Skip to next paragraph
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The United States is the only developed country still hanging on to debit and credit cards with those black magnetic stripes, the kind you swipe through retail terminals. The rest of the industrialized world has switched —or is in the process of switching— to "smart" chip-based cards.
The problem with that black magnetic stripe on the back of your credit card is that it's about as secure as writing your account information on a postcard: everything is in the clear and can be copied. Card fraud, and the measures taken to prevent it, costs U.S. merchants, banks and consumers billions each year.
The smart cards can't be copied, which greatly reduces the potential for fraud. Smart cards with built-in chips are the equivalent of a safe: they can hide information so it can only be unlocked with the right key. Because the important information is hidden, the cards can't be replicated.
But the stripes have been so entrenched in the vast U.S. payment system that banks, payment processors and retailers have failed to reach consensus on how to revamp it, leaving the U.S. behind the rest of the world.
"The card system in this country has been dysfunctional for a long time," says Mallory Duncan, general counsel of the National Retail Federation. "We have far, far too much fraud because we have a very antiquated payment system relative to the rest of the world. This is something they should have fixed a long time ago."
Yet even here, there are now serious moves to swap conventional credit cards for smart cards in a few years.
Last month, Visa announced new policies that will give U.S. banks a reason to issue smart cards and stores several reasons to accept them, starting in 2015.
Eric Schindewolf, product manager for smart cards at Wells Fargo & Co., says Visa's announcement is a "watershed" moment.
"I think that the U.S. has reached a tipping point. You'll begin to see more and more smart cards in the hands of U.S. consumers," Schindewolf says.
Smart cards are recognizable by the fingernail-sized gold contacts embedded on one side. Through the contacts, a chip inside the card can transmit information to a terminal when slid into a slot.
Here's how a smart card works in practice: When it's time to settle the bill at "Le Gaspard de la Nuit," a tiny restaurant just off the Place de la Bastille in Paris, the waiter brings to the table a wireless payment terminal. The customer inserts his chip-equipped "smart" credit card and enters his code on the keypad.
Voila! The foie gras is paid for without the card leaving the customer's sight, and the combination of chip and PIN code kept the transaction safe from fraud.
The U.S. payments industry has so far been locked up in a "chicken and egg" quandary, Schindewolf says. Stores had little reason to install terminals for smart cards if banks didn't issue them, and aside from some contactless cards, banks didn't issue them because stores wouldn't accept them.
The impasse has left U.S. businesses and consumers struggling with higher fraud rates. Richard Sullivan, the senior economist in payments research at the Federal Reserve Bank of Kansas City, says that in 2006, 9 cents out every $100 paid by card in the U.S. ended up in the pockets of criminals. The comparable figure for Spain was 2 cents. Sullivan believes the use of smart cards there is a big reason for the difference. Other factors play a role, too. Spaniards, for instance, are less likely to shop online.