The history of smart-cards and their place in modern Russia

                       St.Petersburg State University
                            Faculty Of Economics



                               the term paper
         The History Of Smart-Cards and Their Place In Modern Russia

                                                       author: Victor Travin

Contents


Introduction     2


What are plastic cards? What kinds of cards exist? 2

  Cards with  magnetic line and memory-cards  2
  Smart-cards: step forward  4
  The developing of smart technology    5

Smart-cards appear in Russia 7

  Smart-cards as bank’s cards     7
  Smart-cards as corporate cards  8

The place of smart-cards in modern Russia    12

  Plastic card payments in Internet     14

Conclusion  15


Sources and literature 16



Introduction

Russian smart-cards market is one of the fastest developing sectors of
country’s financial market. The trial period which was over by 1995 allowed
its participants to learn technologies and problems that can be hit upon
while dealing with “cards” business. The fact that more then 500.000
international plastic cards were issued in Russia for several last years
only approves of the topicality of such payment systems.


What are plastic cards? What kinds of cards exist?


Cards with  magnetic line and memory-cards

Cashless payment  systems based on traditional cards with magnetic line are
dominating world wide. They achieved noticeable improvement in supplying
card owners with many kinds of services. But the fact of internal limits in
magnetic line cards leads to many new problems. These problems are: the
increase of financial risks and losses, administration expenses, technical
problems. This kind of cards has a lot of disadvantages that make their
operation in Russia in same scale as in Europe impossible. The most serious
disadvantage, in my opinion, is that such systems require on-line
authorization in stores and, as a consequence,  they need well branched
high quality communication nets (e.g. telephone lines).Because of this fact
 magnetic line cards systems have a serious restriction for their operation
in the countries with unsatisfactory state of telecommunication systems. I
also have to notice a low security level of magnetic line cards and the
entire technological chain  of such systems.  This often leads to great
flow of unprovided false transactions. This aspect is a serious obstacle to
developing magnetic card systems, especially in the countries with a high
level of criminality.
Memory-cards  belong to chip-cards equipped with memory chip. Payment
systems based on memory cards have important advantages as compared with
magnetic line cards. They have a higher security level and the option of
off-line authorization in stores. Technical abilities of chip built in
memory cards define restrictions to their operating in payment systems
though. We have just the same problem here (as with magnetic line cards) –
unsatisfactory security level of any single card and system in general.
Taking criminal situation in Russia into consideration we have to admit
that this kind of cards can hardly find the appropriate place in modern
Russia. This aspect captures a special place when several banks are
involved in one payment system, where special attention should be paid to
accident prevention and authenticity of financial information,
differentiation of responsibility for keeping a secret information with
transaction members. Main areas for memory-cards are systems of limited
access to accommodation and computer networks (identification cards);
telephone networks (cellular telephone network GSM);  payphone and metro
cards, local payment systems (club cards). Certainly, memory-cards will
find their place, but obviously they will not be ruling in future.
Thus, magnetic line is a medium in magnetic line cards which lowers
reliability and makes multi recording impossible and requires on-line
access.
The chip is a medium in memory-cards. Such cards can be used with off-line
access, multi recording is available, but the procedure is still complex.
Because of low security level running memory-cards is dangerous.


Smart-cards: step forward

Magnetic line cards market is now formed in all developed countries. Giant
infrastructure was created: processing centers, money access machine, trade
terminals, hundreds million cards in use, international standards are
formed and admitted. That is why magnetic line cards will be still in use
for many years.
However, world leaders VISA, Europay, MasterCard have already declared
about inevitable conversion to smart-card technology in future. All of them
started developing future international standards for payment systems based
on smart-cards. Even in Europe where magnetic line cards are traditionally
popular smart-cards are winning one project after another.
The most successful introduction of smart-cards is supposed to take place
in the countries where magnetic cards hold a weak position; in the
countries without high quality well branched and reliable communication
systems; in the countries with a high criminal level where the population
have a low credit reliability.
These days many Russian banks issue traditional magnetic cards of
international payment systems. However, such issues are definitely oriented
on concrete social consumer group and regions of their use are quite
limited.
Now lets say some words about a smart-card. The medium in smart-cards is a
small processor chip. The identification area allows only one record while
personalizing the card and later available for reading only. Access to
other areas available only after the card holder entered the proper “key”.
The smart-cards security level is much higher than the magnetic cards one.
As to prices on smart-cards, they are higher, but they become lower and
lower every year as their technology is being improved and production scale
is being enlarged
The smart-cards are small computers is some way.  Modern smart-card chips
features can be compared with personal computers in early 80’s. Part of the
data located on a smart-card can be used only in internal card’s
operations. This fact together with high level cryptographic security makes
smart-cards valuable asset for financial systems demanding additional
security and reliability. Because of that smart-cards are now considered to
be the most promising kind of plastic cards. They can be also considered to
be the most promising for their features. Smart-cards counting abilities
allow card holder to keep multi-currency wallet. As predicted by VISA and
Europay/MasterCard, smart-cards will replace magnetic line cards within the
10 year period.


The developing of smart technology

First smart-cards appeared in France in the middle 70’s. The main
advantages as compared to magnetic line cards are higher reliability,
security and multifunctionality. The main disadvantage that it is still
difficult to get over is high prime cost.
Nevertheless, in early 90’s rapid growth of smart-cards market took place.
Thus, at the last smart-technology forum (SmartCard Forum), hosted in the
USA,  statistical reports showed that the majority of magnetic line cards
owner would use smart-cards as electronic wallet if their bank issued such
cards.
But financial institutes that working with smart-cards have a lot of
questions at the moment.  Many of these questions still do not have
answers. Here are the most popular ones:
    V How high is the level of smart-cards security?
    V What schemes should be used for transactions: open or secured?
    V How available and reasonable is the complete replacement of cash with
      electronic money?
    V What authorization mode is better: on-line or off-line?
The fact of existence of these questions demonstrates that there is a high
interest in smart-cards connected with an ability to transform little sum
payments into cashless payments. Visa researches show that annually more
then 1,8 trillion dollars happen to less then 10 dollars transaction.
Obviously operation of these payment through electronic cards is more than
attractive. But the organization of such transformation hits upon serious
problems even in well developed countries. In this case solving this
problem with a help of electronic wallets seems to be the most effective.
According to  Jean Jacques Debone, the president of European branch of Visa
International “the development of smart-cards, allowing the client to make
less then 8 dollar payments, will treble bank’s cards profit”


Smart-cards appear in Russia


Smart-cards as bank’s cards

BGS Smartcard Systems AG is the official dealer and distributor of Visa
International smart-technologies is Russian and the former USSR market. It
was founded in 1997 and holds right for software and technologies of
cashless payments based on U.E.P.S standards.  U.E.P.S. – universal
electronic payment system is a system based on smart-card technology. The
main technological feature of U.E.P.S.  is that all transaction operations
are done in off-line mode trough direct contact of two smart-cards. BGS
introduced several large projects for Sberbank of Russia, Promstroybank,
Inkombank and some other banks and bank’ unions in Russia, the leading
banks of Uzbekistan, Ukraine and Kazakhstan. In September 1996 BGS signed
the agreement with Visa International on developing and migration of smart-
card product COPAC including U.E.P.S. as a basis.   The matter for greater
interest is joint project with Sberbank on creating the united smart-card
system (SberCard cards). Taking scale of spreading and recent issue date
into consideration we can say that SberCard is on of the most promising
card in Russia.
On Sep 13 1996 during annual meeting of banks-members of international
payment system VISA International announced a new product – a new plastic
card with microprocessor Chip Off-line Preauthorized Card. This product has
no special brand name yet, abbreviation COPAC was taken as a working
version of a brand name.
Since 1992 BGS company has exclusive right for distribution U.E.P.S
technology in the former USSR, Western Europe and Austria.
VISA International declared in the second quarter of 1997 of the new pilot
project with Sberbank of the Russian Federation and Inkombank (Union Card)
on introducing COPAC technology. After this the pilot project was over new
COPAC specification became
available world wide.

Smart-cards as corporate cards

The greatest company offering corporate integrates smart-cards systems in
Russia is IT company. Founded in 1990 today Information Technologies Co.
(I.T. Co.) ranks among the top three Systems Integrators in Russia,
according to the Dator marketing agency and Russian Computer Union opinion
poll statistics. Reporting annual revenues in excess of $27 Million, I.T.
Co. has deployed over 500 projects in Russia and the CIS for industrial
enterprises, trade companies, government, and financial institutions. In
1996, Computer Press magazine granted I.T. Co. an award “For Outstanding
Results in Developing the Russian Computer Market”, and was included into
the State Registry of Quality Systems. Having extensive experience in the
development of information and computing systems, I.T. Co. has created a
broad product line of private-branded high-tech software and hardware
solutions for the local and international market. Since 1990, I.T.Co. has
focused on meeting the demands of what is now today's competitive global
marketplace. As businesses, large and small, progressively long for ways to
interface with all of their suppliers using one system -- a complete
information management system that is specifically designed with the
customers' needs in mind, and just as importantly, a system friendly to the
bottom line -- I.T.Co. remains on the forefront of technology, delivering a
quality product on time, and on budget
I.T. company has developed their own conception of smart-card systems
CmartCity. Besides SmartCity  technology department proceeds developing and
promotion of new systems of controlling and managing banking accounts
through Internet. This project is based on the client-server software on
personal finance managing DEKART, a new solution in electronic commerce
area.
SmartCity is a “card” product of I.T.  The company together with its
suppliers created several large-scaled projects based on this system.
I would like to stress three projects of this company in Russia.
One. Cashless payment system “Meta Card” based on SmartCity technology for
Metkombank, Cherepovetz. System projected “power” is 50.000 cards, with 300
trade terminals. This number covers 75% of town’s stores and trade points
and services. The card holder can use his card not even in Cherepovetz but
in Metkombank affiliates in Vologda too.
Two. Cashless payment system for gas filling station “LICard” also
SmartCity product. This system was created for oil company Lukoil and
Imperial Bank in Volgograd, Perm, Vologda, Cheliabinsk and Baku for 100.000
cards. Further developing of the project provides organization of cashless
payment for Lukoil gas station  on entire territory on Russia with 300.000
cards issued by 2003.
Three. Cashless payment system for Purneftegas in Gubkinsky in Tumen
region. This project provides 31.000 cards. More then 100 terminals were
installed to deal with smart-cards in food, bakery stores, airline booking
offices. All in all in 50 trading and servicing places in Gubkinsky.
Lets take a proper look at “LICard” project. In my opinion, it is the most
promising one.
Lukoil corporation has big and constantly growing number of filling
stations in all regions of Russia and many countries of the former USSR.
The company plans not only further grown of number of gas stations but also
widening the specter of provided services including cashless payments by
plastic cards.
While creating  corporate electronic payment system on company’s filling
stations and terminals the following aims were pointed out:
    V Increase of financial arrivals to Lukoil;
    V Creating of information database for making managing decisions;
    V Exploring new sales markets.
Lukoil fuel cards are used in several regions (Volgograd, Chelyabinsk, Perm
and others) for years. In every separate region cards functionate well. But
the problem of unite system was not solved yet. The card holder cannot use
his card in another region but only where he has bought his card. That’s
why the question of unification of the system of electronic payments
appeared where cards could be acceptable at every filling station.
The main criterion while choosing the technology for organizing cashless
payments was the low level of telecommunication systems in Russia, which
makes on-line transaction almost impossible. Thus, it was decided to use
smart-cards to operate the special processing center instead of on-line
transactions (off-line). The second argument for smart-cards was high
security level of recorded on smart-card information. Besides, smart-cards
are available for many kinds of application which was also important for
this project.
It was decided to use smart-cards produced by GemPlus company in SmartCity
technology for creating corporate electronic payment system for Lukoil
filling station. Every person or company can become a card owner.
Before going somewhere a car driver put his money on his smart-card or
money can be transferred by an organization. And now our driver travels
with a plastic card instead or a huge wallet full of money for his trip.
When filling at Lukoil gas station corresponding sum of money is written
off from his smart-card. If using smart-card driver gets 3-7% discount.
By the end of 1997 LICard system has been in action in greater part of
Russia. Noticeable growth of personal LICard owners was hit upon for the
recent year.
LICard has three levels the scale of ranks as to its organization:
     1. Low level. Regional agencies and service offices, and filling
        stations Lukoil;
     2. Middle level. Regional processing centers and regional
        representative offices of LICard;
     3. High level. Application center and interregional processing center
        LICard.
Transfers between regional centers are carried out through the
interregional processing center. This action allows any filling station to
receive money even if no money was put on the card.
This project can real working example of applying smart-cards for corporate
needs. But I would like to notice that not all features were used in this
project. Using some additional wallets project owner could have more
effective and profitable system.


The place of smart-cards in modern Russia

In this chapter I mean smart-cards under “plastic cards” term. Because
magnetic line cards and memory cards have little chance for success in
Russia.
Our plastic cards market is rather a collage picture. Before 90’s plastic
cards was so badly known that they even were not shown in Soviet films that
showed disadvantages of Western style of living. Meanwhile,  plastic cards
are so deeply integrated in American and Western style of living that
person who has rather big sum of money is cash almost immediately gains the
reputation of a criminal.
Plastic cards are not so wide spread in Russia as in Europe and of course
in the United States. Obviously, the reason is in the lack of necessity of
everyday cashless payments We also have to take average income in our
country into consideration which, unfortunately does not let many citizens
to have enough free money to place then on a card.  There are still many
obstacles in operating plastic cards in Russia: from simple tradition to
call pieces of paper in a pocket money to elementary distrust, fear to
become a victim of another “MMM” speculation project.
Hence placing plastic card into operation in further 3-5 year would not
bring a satisfactory result to any bank, no matter how reliable it is. The
success can be reached only by uniting all existing systems into one
national payment system. But this perspective is now very attractive to the
majority of banks as they are afraid to depend on bigger and stronger
banking groups. Beside that the present level of telecommunication systems
and banking equipment will not let such project to be realized. And great
investments are needed for many banks to proceed the convertion from
magnetic line cards to smart-cards. That’s why I consider putting smart-
cards into operation in Russia rather disappointing in the nearest years.
I think the solution of this problem is in replacing existing systems of
cashless payments with smart-cards technology. Lets take transport fuel
coupons as an example. Obviously, introducing plastic cards in this sphere
will meet the lowest resistance of citizens who got accustomed to other
kinds of cashless payment for fuel. Such systems are good for both: people
and oil companies. People are glad to carry one small card instead of a
bunch of coupons and to be sure that nobody else would use their fuel
credit even if their card is stolen. Oil companies gets valuable assets
with such systems as they ensure themselves from serious losses connected
with coupon falsification. And if we mention speeding up money return, it
becomes absolutely clear that such systems will soon appear in our life.
After fuel smart cards are introduced, additional wallets can be added to
the same cards. For example, on one and the same card fuel credits can be
recorded (in litres), some technical service for cliens car (in working
hours), dinners in filling station cafe (in number of dinners). It that
situation our driver can travel with a little sum in cash and his smart-
card.
Besides, using plastic cards instead of coupons territory depending problem
can be easily solved, as direct and strong “coupon” connections already
exists through oil companies.
Thus, in my opinion, the process of introduction plastic cards should start
not from banking but from trading sphere. The ideal case could be the
combination of corporate, banking and international cards into one.

Plastic card payments in Internet

Another stimulus for developing smart-cards is active growth of selling
trough international computer network Internet. Unfortunately it has not
received enough development in Russia. Although there are companies selling
goods through Internet (music CD, books, computer) payments are still
processed after an old manner: client pays the money after he gets the good
at the post office. Hence there are some noticeable losses because of
payment delays.
The situation in Europe and the United States is quite different. Companies
sell almost everything from pens to cars and cottages through Internet and
such activities give real profit. For example, on 10 May 1999 Apple virtual
computer store sold equipment on more than 1.9 million dollars – a record
during short history on Internet selling.
In trading part of the Internet the decision to converse from magnetic line
cards to smart-cards has been discussed for more then 3 years. As e-
companies  incur constant losses because of low security level of magnetic
line cards If such decision is made we will have the right to say that it
will be a final victory of smart-cards over their out of date congeners.


Conclusion

The above analysis of operating smart-cards as modern international payment
tools allows me to make the following conclusions:
1. Impressing results are reached in realization of smart-technology and
   applying different kinds of plastic cards payment systems in
   international markets.
2. The process of developing plastic cards as universal payment systems is
   in a phase of rapid growth in Russia
3. There is a clear tendency of intellectualization  of plastic cards,
   based on modern technology chip equipment and electronic communications.
4. Year 2000 will define tendencies of plastic cards developing once and
   for all.
5. The most promising way of introducing smart-cards in big Russian cities
   is in creating local systems of small sum cashless payments with their
   further unification into one national cashless payment system.

Sources and literature


1. Mike Hendry. Smart Card Security and Applications (Artech House
   Telecommunications Library). Artech House. September 1997
2. Catherine A. Allen. Smart Cards : Seizing Strategic Business
   Opportunities : The Smart Card Forum. Irwin Professional Pub. November
   1996
3. Jose Luis Zoreda. Smart Cards. Artech House. December 1994
4. Ron E. Gielgun. 1 Business, 2 Approaches : How to Succeed in Internet
   Business by Employing Real-World Strategies. Actium Publishing. September
   1998
5. Bruce J. McLaren, Constance H. McLaren. E- Commerce : Business on the
   Internet (Computer Applications Series). South-Western Pub. June 1999
Other sources:
1. WWW-server of Visa Internetional http://www.visa.com
2. WWW-server of  MasterCard International. http://www.mastercard.com
3. WWW-server of BGS Smartcard Systems AG. http://www.bgs.ru
4. WWW-server of  company «I.T.» http://www.it.ru
Special thanks:
Erik Przekof. Consumer Credit Counseling Services. Farmington Hills, MI,
USA
Tyra Turnquest. CCCS of the Gulf Coast & Money Management International.
Houston, TX, USA