5 February 2014
In the wake of the Target security breach, there's been a fair amount of hand-wringing about why the US has lagged most of the rest of the world in deploying EMV (Europay, MasterCard and Visa)—chips—in credit cards. While I certainly think that American banks and card issuers should have moved sooner, they had their reasons for their decision. Arguably, they were even correct.
To understand the actual logic, it is necessary to remember three things:
- The bankers who decided to stick with mag stripes are most certainly not stupid.
- More security versus less security is not a moral issue, it's a financial decision.
- Security technologies have their own costs, some of which are not obvious.
Security mechanisms are not selected randomly. Rather, they're deployed to counter specific threats. If you don't see a threat that would be countered by EMV, there's no point to using it. One major source of loss—fraud on card applications—is not addressed at all by EMV. Forged cards have long been an issue, but on a small scale; this could be dealt with by things like holograms and quick revocation. Yes, datatbases of credit card numbers existed, but for the most part these weren't at risk; there was little, if any, network connectivity, and the criminal hacker community had developed the tools to get at these databases.
(Those databases of card numbers turned out to be very important. Most people use a very few credit cards, often just one; that means that your credit card number is effectively your customer ID number. You behavior can be (and is) tracked this way, especially if you buy both online and in a physical store.)
Quick revocation, implemented when merchants started deploying terminals a bit over 30 years ago, was very important. Before that, stores relied on books listing canceled card numbers. These books were issued at most weekly, and were cumbersome to use; as a result, they were generally consulted only for large transactions. (Exercise for the reader: at the conclusion of this blog post, explain why this behavior was quite rational.)
In other words, by around 1995, life was pretty good for American credit card accepters. There was a relatively cheap technology (mag stripes plus online verification), good databases for tracking, and decent law enforcement.
Life was different in Europe. Countries are much smaller, of course, which means that there's more cross-border travel; this in turn hinders law enforcement for cross-border crime. (Not very many Americans travel abroad, so there's not nearly as much of a cross-border issue affecting American banks.) For whatever reason, online verification terminals were not deployed as widely, but crime was increasing. (I've heard that different costs for telecommunications service and equipment played a big role, but I haven't verified that.) There had a second mover advantage: they hadn't invested as much in mag stripe technology, and in the meantime smart cards—chips in credit cards—had become feasible and affordable, which was not true circa 1980.
One element of the cost, then, is the infrastructure: the myriad terminals that merchants own, and the server complexes that accept and verify those transactions. None of that would work with EMV cards. Other costs, though, are more subtle. In one ironic example, Target itself tried deploying EMV ten years ago: Target was both an issuer and accepter of credit cards. It turned out, though, that processing a transaction with an EMV card is slower, which meant long lines at cash registers— lines that their competitors didn't have, because almost no one else in the US was using EMV.
This, then, was the problem: high conversion costs, high operational costs, disadvantages for early adopters, and little consumer demand for the chips—American consumers aren't responsible for fraudulent use, and as noted few Americans travel abroad where they might need the chips. Combine this with the lack of a significant threat model, and the decision seemed obvious: the financial calculations indicated that it wasn't a profitable move. Yes, there would be some loss due to preventable fraud, but the cost of that prevention would be greater than the likely losses. As noted above, fraud prevention is strictly a financial decision.
What happened, of course, was that the threat changed dramatically. Hackers did learn to penetrate store server complexes and card processors. The conversion is now an urgent matter, but it will still be years before most transactions in the US will involve chip-enabled cards and terminals.