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fm02Many discussions of security standards emphasize how Chip + PIN and Two Factor Authentication reduce fraud loss and exhort countries using Magstripe / Chip + Signature and Single Factor Authentication (e.g. USA) to immediately migrate to the newer technologies. Take for instance Campaign pushes for US adoption of chip and PIN on Finextra.

All these urgent missives totally miss one thing that merchants and banks know only too well: They make revenues only when the transaction is successful, not when it’s blocked for being potentially fraudulent. In other words, mitigating fraud does not pay the bills.

I’m not for a moment suggesting that merchants throw caution to the winds but am only imploring regulators to remember that an obsession with fraud control could hit sales and cause customer dissatisfaction.

This is because virtually every security measure designed to prevent fraud creates collateral damage by way of increased friction viz. need to remember the PIN in the case of an offline Chip + PIN transaction. Security pundits have been claiming for years that there are ways to implement security without compromising on convenience. But there are too few implementations of such technologies in the mainstream market for merchants to take these claims seriously.

The amount of incremental friction caused by a security measure needs to be seen in the context of many factors specific to local culture and business practices viz.:

fm03Cards Per Customer

If consumers have only one card, remembering just one PIN is not a big deal. However, if they regularly use multiple cards, the need to remember multiple PINs poses a lot of friction. (Most probably, people belonging to the latter category would write down all their PINs on a piece of paper and keep it inside their wallets, which would defeat the basic purpose of security.)

Recourse Against Fraud

In some countries (e.g. USA), when a cardholder spots a fraudulent charge on their credit card statement, they can report it to their bank and have it reversed, pending chargeback investigation carried out by the bank behind the scenes. So, compared to their ease of seeking recourse against fraud, even a simple PIN might seem like a lot of friction. On the other hand, in some other countries (e.g. India), a cardholder caught in a similar situation gets shunted around between the issuer, acquirer and the merchant, so they might be willing to jump through a few more hoops while making the payment. As a result, in the latter countries, if the regulator insists on stringent security measures like two-factor authentication, consumers may be encouraged to try them out. But if the additional hoops lead to failure of payment because of loss of Internet connectivity or outage of one of the systems in the chain, their enthusiasm wanes and they go back to other forms of payment that carry less risk of failed payments.

The impact of friction is two fold:

  1. Customer abandons the transaction and the business suffers a loss of revenue, or
  2. Customer completes the transaction with an alternative method of payment viz. cash. Let’s assume that the merchant suffers no net cost impact in this case since the incremental cost of cash handling could be offset by the savings on credit card processing fees.

So, while steps taken to mitigate fraud could lower fraud loss, they could also stunt revenues. This has to be kept in mind before any new payments security technology can hope to achieve mainstream adoption.

Therefore, any discussion about payment security is complete only when it addresses both

(A) Fraud loss as % of Sales, and

(B) Revenue loss.

In the migration from magstripe / Chip + Signature to Chip + PIN for offline payments, it’s too early to predict which of these two metrics will prove decisive. But, in the related case of online card payments, it appears that fraud loss has proven to be not as critical as concerns over revenue loss owing to friction, given how leading merchants like Amazon have still not implemented 2FA (VbV / MSC / OTP) despite the fact that FFIEC issued guidelines for 2FA way back in 2005 and renewed them in 2012.

fm-fiI’m not alone in advocating a balanced approach towards payment security. “The challenge is friction from a checkout point of view. If merchants are looking for security perfection, then they are going to be turning away good sales.”, says George Peabody, a partner at Glenbrook Partners here. “When you are doing checkout out of a merchant’s shopping cart − particularly on a mobile device − it is really important to be as friction-free as possible.”, he adds.

End of the day, it all boils down to how a business wishes to treat the risk of fraud loss – or any other risk, for that matter. If they follow the advice of Sam Zell, the famous American real estate magnate and private equity investor, they’d analyze the risk unemotionally and take it if they get commensurate returns. Not because the technology thrust on them is new or old.

Ketharaman Swaminathan On August - 7 - 2015

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