The US is enamored with outdated and costly modality that is costing Billions in lost revenue and fraud. While many argue the business case for moving to technology like EMV or NFC is hard to justify, the reality is it is incredibly simple to justify based simply on mathematics around today’s massive cost of fraud. The same goes for those that say shifting the US away from checks is too hard because of the momentum in the system.
The big cost of fraud
In the US alone, check (cheque) fraud costed US consumers and banks an estimated $20Bn a year in 2010, up from $10Bn in 1997. Identify theft is one of the fastest growing types of fraud. In the US identity theft victims grew by 12 percent to 11.1 million adults in 2010 (Source: Javelin Strategy & Research, “Identity Fraud Survey Report,” February 2010). 43% of this fraud, totaling more than $50Bn in costs, were check and card fraud. This doesn’t include the Billions of dollars spent internally by bank risk and fraud departments chasing, tracking and attempting to recover losses from fraud.
In 2009, three individuals were accused of engineering the largest case of card fraud in US history. The fraud involved the theft of more than 170 million credit and debit card numbers utilizing weaknesses in the payment processing systems based around mag stripe tech. Albert Gonzalez, the primary defendant in the case, was said to have thrown himself a $75,000 birthday party and complained about having to count $340,000 by hand after his currency-counting machine broke. The state retrieved around $1.65m in cash as part of a plea bargain, but the Secret Service identified that just one small part of Gonzalez’ operation a group of hackers called “ShadowCrew” took $4.3 million in the early part of the decade. It was also reported that Heartland Payments Systems Group, who was targeted by Gonzalez’ group, lost more than $12.6m in the attacks alone (source: Wikipedia).
Estimates for card fraud in the US banking range from around $5.7Bn a year to $8.6Bn a year (source: Oracle Financial Services Whitepaper).
Outdated technology killing the US banking system
There are various arguments given for keeping checks and mag-stripe going in the US, despite all evidence to the contrary. The biggest argument for keeping checks going is the momentum in the system around checks that stem from the practice of the mystical ‘float’ mechanism. The float has frequently been used as a mechanism in the practice of cheque kiting or ‘playing the float’, convincing a merchant to accept a cheque that takes 3 days for the fraud to become evident. Since cheques include significant personal information (name, account number, signature and in some countries driver’s license number, the address and/or phone number of the account holder), they lead directly to identity theft implementation.
In Germany, Austria, the Netherlands, Belgium, Finland, and Scandinavia, cheques have almost completely vanished in favour of direct bank transfers and electronic payments. In the UK, Ireland and France, while cheques are still used they are in rapid decline, with 95% of merchants not accepting them as a form of payment anymore. The key difference in EU markets where cheques have disappeared versus the US are two simple mechanisms:
- Cheques cost consumers to process, whereas electronic payments are free or cost less, and
- There are robust electronic payments systems like Giro that provide alternatives that are more efficient
As long as US banks insist on free checking and charging for wire transfers, along with a poor interbank payments capability, then checks have life left in them. Why they insist on this is beyond me?
Mag-stripe related fraud was successfully reduced by 75-80% in the UK and France as a result of the introduction of EMV chips. This is expected to be further reduced dramatically by the introduction of NFC and mobile payments, which allow multiple additional layers of security.
Savings pays for all the innovation we need
In the US alone check and card fraud costs close to $30Bn a year. By incentivizing the removal of checks and mag-stripe from the system, this could result in savings well in excess of 50% of these costs annually. $15Bn a year could pay for a lot of innovation.
In 2010 over 1.5million card terminals were shipped in the US. Accepting that these units cost around $1-3k to deploy, replacing mag-strip capable terminals annually would only cost around $10m for 3m merchants, $100m for 30m terminals. That solves the NFC/EMV issue very quickly.
Interestingly, removing cheques from the system not only reduces fraud, but reduces processing costs internally within banks by some 30-40%. Far in excess of the gains from the mystical float.
Mobile payments and NFC are clearly not only the way to go to reduce fraud, but to provide a massively robust business case for innovation. Anyone who argues for the longevity of cheques and magstripe in the US needs their head read IMHO.