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June 27, 2011

What are you signing away with a signature instead of a PIN on card transactions?

Recent years have witnessed the commercial banking industry making some surprising risk management decisions. For instance, many financial institutions encourage their customers to choose the credit/signature option of their debit cards rather than the debit option. But the credit option is more vulnerable to fraud, so ultimately is more costly to the industry. In addition, signature debit transactions are processed through the credit card networks, which means the banks earn the higher interchange fee that comes from credit transactions as opposed to debit transactions.

The point of this discussion is not to look at the anticipated effect of the Durbin amendment on interchange practices, but instead to focus on the moral hazard presented by these practices in the context of our nation’s retail payment systems. The reason that signature debit carries a higher interchange fee is that it is less secure than PIN debit transactions. In a recent study by the Federal Reserve Bank of Minneapolis, financial institutions reported that signature debit fraud attempts eclipse fraud with other payment types. The report also says that debit cards along with checks are the payment types most often attacked by fraud schemes, and as a result sustain the highest losses.

Payment types with hihgest number of fraud attempts by % of respondents

Source: 2010 Payments Fraud Survey: Summary of Results,
The Federal Reserve Bank of Minneapolis

However, the study also reported that most financial institutions and other organizations report that actual fraud losses as a percent of their annual revenues are relatively small, at less than 1 percent. This information sheds light on the risk-versus-return decision-making rationale.

As the incidence of payment card fraud in general is on the rise, it is time to take a proactive view of the risk management practices for debit card programs. While persuading customers to process debit card payments on card networks may be more profitable in the short run, the industry may realize an increase in fraud and risk in the retail payments system as a result.

Cindy MerrittBy Cindy Merritt, assistant director of the Retail Payments Risk Forum

June 27, 2011 in consumer protection, fraud, interchange, risk | Permalink

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