Lawsuit Provides Peek Behind Curtain of Online Financial Transactions

Judge the importance of GENESCO v VISA not by the $13+ million protested, or the $40 billion Business Insider estimates credit card companies gross annually in transaction fees. What’s really in play are trillions of dollars every few months worldwide in mediated payments and transfers. This peek behind the curtain of online financial transactions is stunning.

That’s a dramatic claim, and it’s almost inevitable that this one case will whimper to a close with only a marginal impact on the whole edifice of bank and merchant payments. At the very least, though, exposure of the case will at least shine a light on a few of the poorly-documented realities of this domain.

Full explanation of the context of GENESCO is beyond the scope of this blog. The essential background is this: credit-card companies are involved not only in the technical business of digital payments, the financial business of credit extension, and various marketing sidelines to capitalize on their customer catalogues. There also is a crucial insurance component in their operations: they guarantee merchants that funds will be “good” very quickly, and protect consumers against several risks as well. The credit card companies assume the security risks of a multitude of frauds and bad debts.

Risk isn’t unique to online financial transactions for credit cards; every mechanism has vulnerabilities. Cash payments can be robbed by stick-up crooks or light-fingered employees; checks sometimes bounce; electronic funds transfers (EFTs) are nuisances to configure and occasionally suffer surprising delays; and so on. While credit card companies inspire abundant grumbles about their steep and often opaque fees (totalling 1-6% on typical retail transactions), those fees support elaborate security infrastructures that, to this point, have largely kept a lid on fraud. Tens of millions of credit-card numbers are stolen one way or another in a typical year, and tens of thousands of “rings” are in operation at any time in the US alone, yet the system as a whole rolls on. A report by a credit-card payment gateway five years ago claimed that losses had substantially declined over the previous decade; more recent indications are that the bad guys have been winning more often. Countering the fraudsters’ increasing technical sophistication is even more of the same on the credit-card companies’ side, with the result that they “… detect these frauds quicker, so we’re not seeing an increase in dollar loss”, in the words of Jim Van Dyke, president of Javelin Strategy & Research.

Part of the system for this happy outcome is an array of penalties for banks and merchants who don’t meet standards. GENESCO is a protest against those penalties, and, more specifically, the unjust and apparently-arbitrary way they’re imposed.

While the suit at hand of course depends crucially on matters of fact and specific details of GENESCO’s situation, it interests me more as a harbinger of difficulties to come. Insurance is a challenging business, with such inadequately-analyzed aspects as moral hazard, so-called “Black Swan” economics, and strong traditions of “security through obscurity”. However GENESCO ends–and both sides have plenty of incentive to settle before they have to answer more questions about their own operations–“business as usual” looks unlikely. Credit-card companies will need to change the ways they do business, and even then they’re nearly certain to lose market share to innovators in mobile and other novel forms of payment.