History of Credit Cards and Payment Processing

With Apps, Mobile Payment Machines and Online shopping being the norm today, it would seem that payments via credit card have always been an easy option, right?

It's tough to remember when merchants used the old 'Knuckle Buster' to make imprints of credit cards.

While those days are long gone (at least in most areas), it's important to understand where the industry came from in order to appreciate what merchant services can offer today.

Let's take just a minute and review the basic history of credit cards and payment processing.

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Credit card processing for the public

The use of non-cash for purchase goes back further than you might think. Perhaps the first instance is traced back to 1914 when Western Union offered a metal card to employees in lieu of a paycheck. Nicknamed "Metal Money", it was only good for purchases at select stores but it was indeed the first method of "using plastic" (or metal).

Things rapidly expanded to a more open system in 1946 called "Charg-It". This allowed customers to charge purchases at local retail stores. Retailers then deposited charges at a bank and the bank then reimbursed the merchant.

The first real credit card didn't appear until the 1950s when Diners Club unveiled the world's first Travel and Entertainment card. The card even boasted 20,000 Diners Club holders by 1951. Later that decade, in 1959, American Express is credited with the first card made of plastic and things really took off from there.

According to CreditCards.com: "The Diners Club and American Express cards' functioned in what is known as a "closed-loop" system, made up of the consumer, the merchant and the issuer of the card."

In 1959, the option of maintaining a revolving balance was also introduced. This meant cardholders no longer had to pay off their full balance at the end of each cycle. While this carried the risk of accumulating finance charges, it gave customers greater flexibility in managing their money.

Debit Cards

The first debit card may have hit the market as early as 1966, according to a report by the Kansas City Federal Reserve. The Bank of Delaware piloted the card, and, by the '70s, several other banks were trying out similar ideas. Also, on June 27, 1967, Barclays Bank launched the first cash machine or "ATM".

Robert Manning, author of Credit Card Nation, said debit card usage picked up in the '80s and '90s as more and more ATMs started cropping up across the country. In 1990, debit cards were used in about 300 million transactions. In 2009, prepaid cards and debit cards were used in 37.6 billion transactions.

The manner in which cards were processed also grew with the industry. Things picked up steam with the creation of bank conglomerations that would all honor the same card. All this time, it is important to note, the entire credit card processing system was entirely paper-based.

All of this changed in the 1970s

Introduction of Electronic Payment Systems

Paper-based systems simply cost too much. Between overhead and lost transactions, the leading players now began to invest in an electronic authorization process. During the early 1970s, this took place via a phone inquiry to a call center to ensure available funds.

The big change appeared around 1975 when National BankAmericard, Inc. (NBI) introduced and upgraded the electronic authorization system. Instead of the typical manual imprint, Visa introduced a highly cumbersome electronic data capturing Point-of-Sale (POS) system in 1979. This was also the year when all major credit cards introduced the magnetic information stripe.

In subsequent years, there were many streamlined POS advancements - but it wasn't until 1994 when a company called Lipman Electronics Engineering, Ltd. created the face of modern credit card processing. It was during that year the company unveiled the first wireless terminal - changing the face of payments and processing forever.

PIN Numbers

The next major advancement to come along was the ability to let customers enter their PIN number when using their debit card just like an ATM. This was called "On-Line" debit because it could check and make sure funds were available in your account, in real time, before approving the sale.

WHAT A BREAKTHROUGH! This made it simply an electronic and guaranteed check which was processed by new "Debit Networks" like Shazam, Cirrus, Plus, etc. Since the risk was much lower, the debit networks could charge less than the credit card networks like visa, etc. This made it very attractive to merchants and the industry proceeded to update every merchant across the country to machines with PIN pads so they could take the On-Line debit cards.

At this time there were hundreds of different styles of machines out there that had been developed over the years and this push to PIN debit purged a lot of those big bulky machines from the system; resulting in the small footprint, counter top machines you see today.

The Durbin Amendment

Ok, so everything's moving along fine and merchants who take pin numbers are saving more money, but this only applies to card present transactions where the consumer actually enters the pin and doesn't bypass it.

It's becoming clear to merchants that debit card transactions, whether offline or online, are basically checks and the fees should be a lot less for any debit card regardless of Pin or No Pin, or even if they are keyed in or chip read. Merchants lobbied congress and, in 2010, Dick Durbin help draft legislation that was passed called the Dodd-Frank law and it represents a major time that the U.S. government stepped in to regulate the payment processing industry.

What Did the Durbin Amendment Do?

The Durbin Amendment limits the transaction fees an issuing bank can charge a merchant when a customer uses a debit card, known as interchange fees. The amendment was passed as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Important to note is that this law only applied to banks with over 50 billion in assets and the smaller banks and credit unions would not be affected and fees would stay the same. This was during the aftermath of the big financial crisis and the large banks had few friends left in Washington, or anywhere.

As we said, this was a major change. Overnight, the fees dropped from approx. 1.1% and $0.15 per transaction on swiped, off-line debit cards to .05% and $0.22 per transaction!

If that's not enough, the rate applied to ALL debit cards, regardless of PIn or No Pin and regardless of whether they were keyed or swiped! This was, once again, HUGE!

But not for everyone. If you were a coffee shop selling $5.00 items then the .07 increase per transaction was a death sentence to profits. On the other hand, if you had tickets over $15.00 then you were saving money exponentially.

Note: The banks lost billions of dollars in revenue practically overnight and a lot of people remember how everything in banking changed, from fees to rewards and other things as the banks restructured to handle the lost revenue.

EMV Chip Cards

EMV - Euro, MasterCard, Visa is a technical standard for "Smart" payment cards and for all payment terminals and ATMs that can accept them. The first EMV or chip cards were introduced in 1993 in Europe and have slowly become the industry standard. In 2014, the United States began its migration to EMV and, once again, merchants across the country had to update their machines and systems to accept the new chip cards.

Merchants weren't required, and are still not required, to adopt EMV technology. New machines cost money and the processing cost is the same whether chipped or swiped. There's also no fines or penalties if you don't upgrade. So why bother?

The US is a big ship to steer, and the likelihood that most merchants would drag their feet rather than buy new equipment was pretty high. The idea of charging fines or penalties would just be a mess so the industry had to become creative.

Rather than fines or penalties, the industry announced that starting Oct 1, 2015, there would be a "Liability Shift" for anyone not using EMV technology. Essentially, this meant that if you swiped a chip card and that transaction was disputed, for any reason, then you automatically LOSE. No fighting it or defending yourself or sending signed receipts; you just LOSE. The industry also imposed requirements on the processors to get it done by certain dates, etc.

This worked, and most merchants adopted the technology fairly quickly.

Note: Pay at pump gas stations deadlines have been extended several times, the last deadline was April of 2021 but by then only half the stations nationwide had been updated.

Elements of the EMV Standard

The key element of EMV involves including dynamic digital data in every transaction. This makes chip transactions extremely secure and reduces the risk of counterfeit fraud. When a consumer uses an EMV-enabled card or device to pay at a chip terminal, the transaction is dynamically authenticated, verified and then authorized. The cardholder can use a PIN (Personal Identification Number) or sign to verify that the consumer is indeed holding his or her own card or device.

NOTE: In the US, the standard is CHIP AND SIGNATURE

How does EMV reduce fraud?

In the digital world, payment transactions are getting smarter. At the heart of these smarter transactions is dynamic authentication, which incorporates unique information in each transaction, making it virtually impossible to replicate. The EMV standard has already been adopted in Canada and by more than 80 other countries where it has significantly reduced counterfeit card fraud, saving hundreds of millions of dollars.

EMV cards are smart cards, (also called chip cards or IC cards), which store their data on integrated circuits rather than magnetic stripes, even though most EMV cards still have magnetic stripes for backward compatibility. EMV cards are contact cards that must be physically inserted into a reader.

There are also "Contactless" cards that can be read over a short distance using radio-frequency identification (RFID) technology. Payment cards that comply with the EMV standard are often called "Chip and Pin" or "Chip and Signature" cards, depending on the exact authentication methods required to use them.

NOTE: In the US, the standard is "Chip and Signature" so you still want to save receipts.
Mastercard, however, does have some credit cards out there that ask for a pin (which no one knows) but you can just bypass it by pushing "Enter" like you do to bypass the pin on your debit card.

It's been a long road for credit cards and the way in which they're processed. From the first metal charge cards, to electronic credit card machines, to wireless payment processing on every phone, the industry continues to grow and evolve. In order to really appreciate todays POS technologies and all that Merchant Services has to offer, it's interesting to take a step back and study a little history.

-Mike Wood, 2022, Advantage Card Services

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