Academic journal article Chicago Fed Letter

Debit Card Competition: Signature versus PIN

Academic journal article Chicago Fed Letter

Debit Card Competition: Signature versus PIN

Article excerpt

This article explores costs and benefits of two types of debit card authorization methods-signature and PIN (personal identification number)-for merchants, consumers, and financial institutions. It also considers competition between signature- and PIN-based debit cards in the United States and looks at Canada's predominant usage of PIN-based debit cards.

The U.S. payment system is transitioning from paper-based payments to electronic alternatives, and debit cards are an important part of this transition. In 2003, led by the rapid growth of debit card payments, the volume of electronic payments surpassed the volume of check payments for the first time. Total debit card transactions grew at a compounded annual growth rate of approximately 20% from 8.3 billion in 2000 to 15.6 billion in 2003.1 Debit cards became the most commonly used payment instrument for in-store purchases and accounted for 31% of transactions performed at the point of sale (POS).2

Debit cards allow consumers to debit their bank accounts directly at the POS to pay for an increasing variety of goods and services. For the most part, these transactions can be authorized in two ways-by PIN (personal identification number) or signature. The payments industry in the United States continues to debate which authorization method is superior in terms of both costs and security. The debate is driven by an interesting paradox in debit card usage. According to Mallory Duncan, general counsel for the National Retail Federation, PIN-based debit card transactions are more secure and less costly than signature-based debit card transactions.3 However, three times as many merchants accept signature-based debit card transactions as accept PIN-based debit card transactions.

Furthermore, cardholders perform twice as many signature-based debit transactions as PIN-based debit transactions. Cardholders in the United States performed 10.3 billion signature-based and 5.3 billion PIN-based debit card transactions in 2003.

The debit card debate essentially rests on three issues: cost, fraud risk, and competition between PIN-based and signature-based card transactions. In this Chicago Fed Letter, I consider these issues for the U.S. market I also examine debit card usage in Canada, which offers PIN-based debit cards exclusively.

Some industry observers attribute greater signature-based debit card usage in the United States to misaligned incentives for cardholders and merchants. According to Jeffrey Shinder and Gordon Schnell, partners at Constantine and Partners, lead counsel in a 1997 merchants' lawsuit against signature-based debit card networks, growth in PIN-based debit card usage was limited by bank card networks' Honor All Card (HAC) rules. HAC rules required merchants that accepted Visa and MasterCard credit cards to accept these networks' signature-based debit cards.4 As part of the 2003 out-of-court settlement of the lawsuit, merchants could decline signature-based debit cards issued by either one of the two largest payment card networks while accepting its branded credit card.

Furthermore, the current debit card interchange fee structure may lead to issuers offering greater incentives, e.g., usage awards, to cardholders to use their signature-based debit cards, which are more expensive for merchants to accept. In addition, some PIN-based debit card issuers impose per-transaction fees, while most signature-based debit card issuers do not The debit card interchange fee is the amount of a card sale that the merchant's financial institution (acquirer) pays the card issuer, which the acquirer typically passes onto the merchant. Merchants may prefer to accept PIN-based debit card transactions because the interchange fee on them is generally lower than on signature-based debit card transactions.

Other observers suggest that competition between PIN-based and signaturebased debit cards results in greater benefits for cardholders and merchants. …

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