Is the Debit Card Revolution Finally Here?

Federal Reserve Bank of Kansas City - Economic Review, Fourth Quarter 1994 by Caskey, John P, Sellon, Gordon H Jr

In a typical on-line debit card payment, the merchant enters the amount of the sale into a keyboard and swipes the debit card through a terminal with a magnetic code reader, which records the customer's bank and account number. The customer then enters his PIN number into a keyboard connected to the terminal to authorize the transaction. The terminal transfers this information to a computer, which relays the information to the appropriate electronic network linking the merchant's bank with the bank that issued the customer's debit card. This network, which in most areas is a regional ATM network, contacts the customer's bank and verifies that there are sufficient funds in the account to honor the payment. If there are, a transaction approval is relayed to the merchant's terminal, the customer's bank debits his account for the amount of the purchase, and the merchant's bank credits the merchant's account. Despite the large number of parties involved, the electronic technology employed makes the transaction instantaneous.

A typical off-line debit card transaction follows a similar procedure with three exceptions. First, as with a credit card transaction, the customer generally signs a paper slip to authorize the purchase rather than entering a PIN number. Second, in order to approve the transaction, the network checks whether the customer's total purchases over the previous two or three days are within some preset limit, rather than verifying that there are sufficient funds in the customer's account to cover the payment. Third, the customer's account is debited and the merchant's account credited two to three days after the purchase.

The mechanics of prepaid cards are considerably simpler. Indeed, for special purpose cards, all that is required is a terminal to dispense cards and a merchant base with specialized card readers. Banks need not be involved since the cards are prepaid and the card, rather than the customer's bank account, is debited at the point of sale. When the balance on the card is depleted, the consumer may dispose of the card or, in some cases, may be able to replenish the balance by paying an additional fee.

In countries that use smart cards, banks are typically the issuers. Card holders commonly load value to their card by withdrawing funds from their bank account at an ATM machine. When the card holder makes a retail purchase, the merchant's card reader electronically reduces the balance on the card and transfers the amount of the purchase to the card reader for later deposit into the merchant's bank account.

Role in the payments system

While the concept of a debit card goes back many years, before the mid-1980s the debit card was used almost exclusively in local pilot programs designed to gauge consumer and merchant acceptance. [1] Stimulus for the growth of on-line debit cards came from regional ATM networks, which saw the growth of debit transactions as a way to enhance network fee income. Support also came from Visa and MasterCard, which saw the possibility of using their national ATM networks, PLUS and CIRRUS, as a means of establishing a nationwide debit program. Visa and MasterCard have also been the principal stimulus behind off-line programs because off-line cards use existing credit-card authorization equipment for debit transactions and can be the source of additional fee income.