With the introduction of over 300 million “chip” credit and debit cards into the U.S. market, new concerns have arisen from merchants over increases in false fraud claims. Despite the October 1, 2015 deadline set by card companies for merchants to convert to the new chip system, some companies did not approve merchants’ systems in time. Each credit card company was responsible for coordinating with merchants, but the volume of unapproved chip readers currently stands at about four million out of five million total chip readers.
Purchases made by swiping magnetic strips are ripe for fraud since the strips use the same numbers to authenticate every transaction. The magnetic strips on credit cards represent card numbers when making purchases, but chips mask credit card numbers with unique identifiers for every transaction.
Credit card fraud is usually done with counterfeit cards obtained by stolen credit card numbers. The chips make this almost impossible to do, keeping consumers’ card information more secure. It is important to note, however, that the chip does not change the security of online purchases.
In the past, the cost of fraudulent transactions was taken on by the credit card companies. However, as of October 2015, merchants that do not have new chip systems in place are liable for chargebacks (when the merchant returns a customer’s money to their account, generally for fraudulent charges). The result? Billions of dollars in fraudulent credit card costs have been shifted from credit card issuers to merchants.
But it is not the merchants’ fault that they cannot accept chip cards, since credit card companies are responsible for approving and activating merchants’ chip card terminals to process their respective chip credit and debit cards.
Here is the predicament: both the approval process and the chargeback liability are determined by the credit card companies. This creates problems for many retailers, especially those in the grocery industry, because they are experiencing unprecedented increases in chargebacks.
Since the liability was shifted away from banks, the amount merchants must pay for chargebacks increased. In addition, false fraud claims increased. Customers game the system by purchasing goods at a store with chip readers that are not yet active, then tell their credit card provider that the charges are fraudulent. The money is taken from the merchant and returned to the customer even though no actual fraud occurred. Normally, in these situations, credit card companies return the customer’s money before any money is taken out of the merchant’s accounts.
This is a particular problem for the supermarket industry. Grocers average a profit margin of one to two percent and cannot afford major increases in overhead costs from increases in fraudulent charges.
Merchants are increasingly frustrated since many of them installed the new chip card readers in good faith before the deadline. Chip readers can cost up to $1,000 per machine, meaning merchants have already absorbed this cost. Yet, they are being penalized for the credit card companies’ sluggishness to activate chip card terminals.
In a letter to Visa and Mastercard, Peter Larkin, president of the National Grocers Association, called out this mistreatment. Specifically, merchants are now liable to pay back customers for claims of fraud, their overhead costs increase, pushing their profit margin down even further. As a result, Visa changed its policy on chargebacks by accepting the liability for amounts less than $25 and accounts with over ten chargebacks. This is a temporary step forward, but not an adequate solution to the problem.
The move towards chip cards has come with costs. Consumers might benefit from some increased security in their card information, but merchants are increasingly dealing with the hassle of fraudulent transactions and chargebacks, which is costly for their businesses. Credit card companies are going to have to speed up their onboarding processes to prevent this debacle from getting any worse. Maybe then the consumer confusion over swipe or insert will finally end.
Andrew Meleta is a contributor to Economics21. Follow Andrew on Twitter here.
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