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How the global microchip shortage is affecting the payments industry

  • While chip-based payment cards face the biggest threat, experts say the only aspect of payments immune to the shortage is physical currency.
  • As banks look to address the problem, one of the solutions being discussed is extending payment cards' expiration dates.
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How the global microchip shortage is affecting the payments industry

With the Covid-19 pandemic, the global semiconductor supply chain took a significant hit. Buying microchips became more expensive as cycle times increased. As video game makers, smartphones, and automobile manufacturers evaluated where they stood, the payments industry found itself no less immune.

China, the world’s largest chip manufacturer, went into a series of lockdowns as part of the country’s zero-Covid policy. This resulted in the closure of factories and a drastic decrease in output. China’s lockdowns decreased total chip output by 5.1% in March this year. Additionally, the Russian invasion of Ukraine has made half of the world’s supply of neon, an essential ingredient in manufacturing chips, inaccessible.

The chip shortage has now dragged into its second year, and firms are knee-deep in trouble. In January, a U.S. Department of Commerce survey found the median inventory levels of chips at U.S. companies down from 40 days in 2019 to five days in 2021. Furthermore, the median demand for chips was found to be 17% higher in 2021 than in 2019. This is a major supply and demand mismatch, the department concluded.

The modern payments industry’s most prolific product is the payment card. Most of these cards now use an EMV chip, which stores the holder’s information and enables communication with other devices, like ATMs and POS terminals. So, the bottom line is, as chips are getting difficult to source, cards are getting difficult to produce – and banks don’t like that. After years of getting in the habit of freely making and sending out cards, they are being forced to predict and budget their production.

“Banks can certainly account for and budget their chip use for customers with expiring cards, but of course, you cannot plan for human error. If a customer loses their card, they immediately need a replacement,” Ruby Walia, senior advisor for digital banking at Mobiquity, told Tearsheet. “However, with the chip shortage, that may not be possible.”

“Frankly speaking, the only aspect of payments that can avoid this issue is physical currency.”

Last year, the American Bankers Association echoed this point in a letter that was submitted to the U.S. Department of Commerce. “This is a fluid situation and exact predictions are difficult to make,” it read.

“However, without an adequate chip supply, some payment card issuers could potentially face challenges in consistently delivering the timely replacement of chip cards or issuing new chip cards to meet consumer and business demand in the U.S.”

In 2021, contactless payment card manufacturers saw the prices of EMV-compliant chips increase by more than 50%. A recent Nilson Report study suggests the cost is set to increase further. It forecasts that the cost of producing finished, first-use plastic cards will increase between 5% and 20% this year and the next. 

“These increases follow multiple years of price declines for finished cards preceding the Covid-19 pandemic,” the study read.

As the demand for microchips continues to outpace the supply, experts are expecting an industry-wide failure to deliver cards in time. According to ABI Research, up to 1 billion payment cards are at risk of not being issued over an 18-month timeframe, with 347 million at risk in 2021 and up to 740 million in 2022.

And this delay in card production has already begun.

“I’ve heard reports of 6-to-12 month lead times for new orders, and prices that are ticking higher for new card orders,” David Shipper, a strategic advisor at Aite-Novarica Group, told Tearsheet. “The combination of long lead times and higher prices will cause huge headaches for issuers because running out of card stock can impact their bottom line and cause huge customer issues.”

Shipper added that while the largest impact of the chip shortage is on physical card production, the supply of technologies like card readers is also under threat of disruption. “Anything that uses a chip will be impacted through higher prices, longer production periods, or reduced supply,” he said.

Furthermore, the chip shortage is certainly going to delay the adoption of new technologies. For example, let’s say that a smaller business wants to accept Apple Pay. This naturally requires certain infrastructure to be in place. But, with little access to microchips, a business may have to wait over 6 months for a new payment processing system to be made available and delivered, as these systems also use chips. 

Banks face three specific risks that need immediate attention. First, they need to figure out how to continuously provide customers with new and replacement cards, as the chip shortage gets worse. Second, if people start moving back to cash payments, there is a risk of missing out on revenue. Third, there is a reputational risk and the risk of losing customers to competitors.

One of the primary things that chip technology does for cards is that it helps promote the security and efficiency of card transactions. The microprocessors on chip cards leverage cryptography to generate a one-time code that verifies to the card’s issuer that the card is genuine and not cloned. Additionally, it makes sure that accurate and consistent information is shared with a transaction device. Hence, chip cards are valuable to banks, and the threat of a shortage has already begun setting off alarms for executives at top firms.

“The chip shortage has been an issue for executives for roughly a year now, and if executives weren’t worried before, Russia’s invasion of Ukraine coupled with strict Covid lockdowns in China is certainly keeping them up at night,” Walia said.

“With these issues piling onto existing ones, the microchip supply chain is heading toward DEFCON 1,” he asserted.

While there may not be an absolute solution, and while the industry might necessarily have to wait for a resolution of the supply chokes, there are some steps they can take to immediately address the situation.

Issuers have begun taking actions to prolong the life of existing cards and reduce the number of new cards issued: extending the expiration date of cards, encouraging mobile wallet usage, charging fees for replacement cards, and making the physical card optional. They are also starting new card orders earlier, which helps card manufacturers better plan for new orders.

There is the notion that the industry can start being more flexible about using a mix of the different kinds of cards available, like chip & pin and contactless. If such an approach requires them to use cards based on older technology, new security standards can be introduced to protect customers. A way to do that could be to alert customers about every transaction by notifying them at purchase time so they can detect any unauthorized activity. Cardholders could be granted greater card controls that would allow them to turn their cards on and off, and even limit where they can be used — for example, by geographic region or specific merchants, or what kinds of goods and services they can buy.

Another tactic that could be used is to simply allow cards to be used past their expiration date. While this may sound like a silver bullet that could solve the problem completely, it is probably not doable because too many systems will have to be modified.

Unless there is a sudden and drastic decline in the demand for chips, the supply disruption is unlikely to be resolved. Chip manufacturers have already begun amping up production, increasing prices, and working out their order lists. According to industry experts, the shortage is expected to extend into late 2022, with some even saying that the production of chip-based goods will continue to be delayed until well into 2023. A complete solution is far off, but immediate remedies are definitely needed.

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