Most credit and debit cards will be smart cards by 2010

By Trevor Marshall

Remember the eight-track? In the 1970s, the eight-track was state of the art. About the same time, another magnetic-based technology entered our everyday lives. The magnetic strip was added to credit cards about the same time that the Bay City Rollers were recording Saturday Night and the Bee Gees were working on their Jive Talkin’ album. It’s still found on the back of many of the cards in our wallets and purses today. Even without counting government ID, transit passes, and other magnetic strip-equipped cards, Canadians carry almost 100 million credit and debit cards.

But consider how far technology has evolved in the last 30 years. Compared to today’s MP3 players, the eight-track is Stone Age stuff. Yet the magnetic strip remains a key component in the system that enables Canadians to use plastic in lieu of cash, millions of times each day.

Bring on the new
This is about to change. Credit card companies, banks, card manufacturers and others have been working to introduce smart cards to Canada’s payments system.

Smart cards use a “chip and PIN” process to manage transactions. As the name implies, the cards include an embedded microprocessor that’s able to add, store, delete and manipulate information. Instead of signing a sales draft to authenticate a purchase, the cardholder enters a Personal Identification Number, or PIN, on a keypad—something Canadians already do when making debit-card purchases.

For those who make, facilitate and receive payments via plastic, the principal benefits of smart cards are enhanced security to combat fraud, a faster, more convenient user experience, and the ability to introduce new services onto the cards themselves. That is why the card industry has chosen 2010 as a target date by which most—if not all—of the nearly 100 million credit and debit cards we carry will have been upgraded. Meanwhile, Canadian businesses are upgrading the technology they use to process credit and debit transactions—everything from merchant terminals, card readers on gas pumps, and automated banking machines to networks and back-office accounting systems.

Cards will still include a magnetic strip; Canada is not the first market to migrate but it’s ahead of many, including the United States, and that strip will still be needed south of the border. But by the end of this decade, the plan is to have most domestic transactions powered by chip and PIN.

It’s a huge task. Consider the number of places Canadians use their debit cards. The Interac Association facilitates the use of bank cards in ABMs and at points of purchase, and its Web site notes that Canada had more than 51,000 bank machines in 2005. That same year, more than 391,000 merchants operated more than 571,000 direct-payment terminals.

Fighting fraud
That said, the time is right, according to Catherine Johnston, president and CEO of the Ajax, Ont.-based Advanced Card Technology Association of Canada. “It’s just an interesting business model, finally,”
she said, pointing out that several key factors have aligned to encourage Canada’s payments industry to move to chip and PIN.

For starters, there’s domestic fraud. Johnston said the biggest issue is skimming:
reading information on a magnetic strip and then using that to create a duplicate, counterfeit card. “Chip cards are both counterfeit- and tamper-resistant in a way that mag strips can’t be,” she said. “Chips are locked: when we make them, we put encryption keys on them and we lock them, and people who are trying to unlock them, who don’t have the proper keys, end up destroying the cards.”

Another factor is fraud migration. Chip cards are already in circulation in Europe and Asia, and as those payment markets become more secure, con artists are looking to countries where magnetic strip cards are still the standard. That means less advanced countries will get hit harder by fraud. “There will be a need for more confidence in the payment system,” said William Giles, vice-president, Emerging Technology at MasterCard Canada. “We’re at a stage where we see things coming. It’s like a rain cloud on the horizon, and we want to fix the roof while it’s still sunny.”

Merchant benefits
Beyond combating fraud, the move to smart cards represents a compelling business case to merchants to upgrade their systems. “Chip and PIN allows merchants to create a fair number of operational costs savings within their organizations,” said Allen Wright, director, Chip Initiatives at the Visa Canada Association. When a cardholder uses a chip card and enters a PIN to authenticate the transaction, merchants need only print one receipt—the customer’s—for each transaction. That saves on paper. And because using a PIN is faster than requesting and checking a signature, chip cards can speed up the payment process significantly for high-volume retailers such as big box chains and major grocery stores.

Furthermore, Visa and MasterCard note that chip cards enable new methods for authenticating cardholders. For example, hand-held devices can generate one-time codes, similar to those used to allow remote computer users access to corporate networks. In use, a cardholder wishing to make an online purchase would insert the card into the device and enter the PIN. The device would then generate a unique code the cardholder could type into an e-commerce portal.

“The cardholder can prove that the card was there for the transaction: it takes a ‘Card Not Present’ transaction and turns it into a ‘Card Present’ transaction, and that makes it much more secure,” MasterCard’s Giles said, adding that these authentication devices will be good news for e-commerce. “Right now, people are starting to lose confidence in using cards for Internet payments. But more importantly, the merchants doing these transactions will decline to do certain transactions because they’re not confident cardholders are who they claim to be. And about three of every four transactions they decline would have been good transactions.”

Easy introduction
Michelle Warren, senior analyst at Toronto-based Partner Research, expects Canadians to welcome smart cards into their lives, and their wallets. “Canadians are really used to paying by debit, so that habit of swiping a card and entering a PIN—we’ve become really accustomed to that,” she said. “Being able to transfer that habit onto a Visa or MasterCard is going to be an easy and quick adoption.”

Still, the payments industry has some issues to address to ensure the successful introduction of smart cards. “I think the biggest obstacle will be the investment on behalf of retailers. In terms of getting smart card readers in place, that’s a technology buy so that’s what issuers, acquirers and merchants have to look at. If it’s upgrading computer systems, that’s a purchasing decision. And for their employees, it’s a little bit of an educational component—to teach employees the new process,” Warren said. “For consumers, I think once employees are trained and familiar with the equipment, it’s just a matter of showing customers how to use it, so I don’t think that will be a huge barrier.”

Chip evolution
One of the world’s leading card manufacturers, Munich-based Giesecke & Devrient, is betting smart card functionality will continue to improve in Canada. “The exciting part about this move to chip and PIN for us as a manufacturer is the opportunity to evolve the entire payment industry in Canada from a technology that is rather static and simple to something that is robust and dynamic,” said Kim Madore, vice-president, Emerging Technology at Giesecke & Devrient.

In October, the company cut the ribbon on a 125,000-square-foot state-of-the-art manufacturing facility in Markham, Ont., and has expanded its Canadian R&D and production activities. “We knew this particular evolution was going to be happening in Canada and we knew we needed to be prepared for it,” Madore said. “Smart cards not only address payment issues, they also address government sectors, telecom, transportation, and other sectors—and we know there’s going to be a big move, as we move into 2010, to conversions to smart cards in many different market segments.”

When Madore gazes into her crystal ball, she sees a time when cardholders will be able to tailor smart cards to their individual needs. She expects loyalty cards will eventually be amalgamated with credit cards, and that consumers will use smart cards to store everything from digital signatures to login information for Web sites. “Are issuers ready for this? Maybe not right yet,” she said. “But as the technology gets out there to solve the primary concern—the fraud market—we’re going to have to start thinking about those additional services.”

Warren at Partner Research agreed. “We’re not going to just see smart cards coming into our lives when we’re buying something,” she said. “We’re going to see a whole proliferation of smart cards over the next five years. They’re going to be everywhere.”