Debit Card Background
Debit cards are broadly defined as cards that enable the cardholder to debit (withdraw or spend) a bank account in order to obtain cash (e.g. from an ATM) or to make a purchase, using the ATM or credit card infrastructures.
The first debit cards were introduced in the early 1980’s to enable consumers to obtain cash from ATMs by debiting their bank account. These early “ATM cards” were not accepted by merchants. In the mid-1980’s, merchants began to install Point-of-Sale (POS) devices with PIN pads to enable cardholders to pay using these cards by debiting funds from the consumers account and providing good funds to the merchant. Supermarkets, gas stations, and other merchants with high volumes of low-dollar payments led this effort. In the early 1990’s, debit cards were enhanced with a Visa or Mastercard logo, creating “offline” debit cards as described below. This latest enhancement allows cardholders to also use their debit cards wherever Visa or Mastercard credit cards are accepted.
Because debit cards typically withdraw funds from checking accounts, many issuing banks refer to debit cards as “Check Cards”. While there are similarities with checks, debit cards borrow more attributes from credit card and ATM practices. To the customer and the store clerks, debit cards work like a blend of ATM and credit cards at the Point of Sale. Some cards require PINs to be entered, others, like credit card transaction, do not. When a PIN is used to authorize the transaction, an Online Debit Card Transaction is generated, and when a signature is used, an Offline Debit Card Transaction is generated.
Online Debit Card Transaction
An online debit card transaction creates an online authorization that verifies the card and PIN, and determines if the bank account has sufficient funds to cover the transaction amount. If approved, the purchase is completed at the merchant location and the purchase amount is reserved from the consumers account. Financial transactions are typically processed and settled at night through a clearing facility such as the regional ATM networks for all purchases made that day. Costs for an online debit card transaction are usually based on a fixed fee.
Off-line Debit Card Transaction
An off-line debit card transaction creates an online authorization that verifies the card and determines if the bank account has sufficient funds to cover the transaction amount. If approved, the card-holder is asked to sign a receipt (like a credit card receipt). Settlement of that transaction is typically split, and occurs over several days: to the merchant the transaction is settled along with all credit card transactions typically that night. For the card-holder, the amount will be debited from their primary checking account within 2-3 days. Many banks, however, reserve the funds immediately from the cardholders account, making it appear that the transaction settled immediately. Costs for an offline debit card transaction calculated in the same manner as a credit card transaction, that is, they are usually based on a percentage of the total transaction amount.
To use an Electronic Check (eCheck) to make a purchase or pay a bill, the Electronic Checkbook card, in conjunction with a secret PIN, is used to create an all-electronic check (a legally binding promise to pay) with a digital signature. This signature is used by the merchant/biller and the banks involved to authenticate the check. Digital signatures provide very strong security, enabling the eCheck to be used over public networks like the Internet.
Comparing echecks and debit cards
Debit cards are used by individuals, and to a far lesser extent by businesses, to make payments at the point-of-sale in a retail environment, or to obtain cash from ATMs. Security techniques used for credit card payments over the Internet (e.g. SET) are also being used for offline debit cards. eChecks can also be used for retail point-of-sale payments and secure bill and business payments over the Internet.
Unlike debit cards, though, echecks can also be used by individuals as well as businesses to receive payments. eChecks, like their paper check counterparts, are likelier to be used by businesses.
Due to the risks associated with debit cards described below, most debit card issuers place daily limits on the amount that can be charged against a debit card, even when the account has sufficient funds. Since echecks, like checks, are the liability of the customer, not the bank, echecks will likely not be subject to the same restrictions.
Liability and Risk
When an issuing bank authorizes a debit card transaction, it assumes the obligation for providing good funds for that transaction. Banks assume a temporal risk, particularly for offline debit card transactions where there can be several days between the authorization and the settlement during which time the consumers account balance may fall below the purchase amount.
Consumer protection is provided under Reg-E for debit card transactions and for eCheck based upon the consumers authorization (e.g. cardholder agreement, provision of a PIN or signature for processing).
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Liability and flow for insufficient funds varies. Because checks are the obligation of the check writer, they can be returned by banks to the depositor for insufficient funds. Authorized debit card transactions become the obligation of the bank, and cannot be returned in most cases. As a result, merchants generally have more stringent authorization procedures for checks than for debit cards (e.g. a check must be accompanied by a store’s “courtesy card” or other form of identification).