> As long as the costs of fraud are borne by the individual merchants I doubt it will be fixed. Fundamentally flawed system design / perverse incentives.

Sure, but be sure to empower consumers against the banks if you make the banks liable instead.

I've always found this case study from the classic "Why Cryptosystems Fail" fascinating:

In some countries (including the USA), the banks have to carry the risks associated with new technology. Following a legal precedent, in which a bank customer's word that she had not made a withdrawal was found to outweigh the banks' experts' word that she must have done [JC], the US Federal Reserve passed regulations which require banks to refund all disputed transactions unless they can prove fraud by the customer [E]. This has led to some minor abuse - misrepresentations by customers are estimated to cost the average US bank about $15,000 a year [W2] - but it has helped promote the development of security technologies such as cryptology and video.

In Britain, the regulators and courts have not yet been so demanding, and despite a parliamentary commission of enquiry which found that the PIN system was insecure [J1], bankers simply deny that their systems are ever at fault. Customers who complain about debits on their accounts for which they were not responsible - so-called `phantom withdrawals' - are told that they are lying, or mistaken, or that they must have been defrauded by their friends or relatives.

The most visible result in the UK has been a string of court cases, both civil and criminal. The pattern which emerges leads us to suspect that there may have been a number of miscarriages of justice over the years.

* A teenage girl in Ashton under Lyme was convicted in 1985 of stealing £40 from her father. She pleaded guilty on the advice of her lawyers that she had no defence, and then disappeared; it later turned out that there had been never been a theft, but merely a clerical error by the bank [MBW]

* A Sheffield police sergeant was charged with theft in November 1988 and suspended for almost a year after a phantom withdrawal took place on a card he had confiscated from a suspect. He was lucky in that his colleagues tracked down the lady who had made the transaction after the disputed one; her eyewitness testimony cleared him

* Charges of theft against an elderly lady in Plymouth were dropped after our enquiries showed that the bank's computer security systems were a shambles

* In East Anglia alone, we are currently advising lawyers in two cases where people are awaiting trial for alleged thefts, and where the circumstances give reason to believe that `phantom withdrawals' were actually to blame.

Finally, in 1992, a large class action got underway in the High Court in London [MB], in which hundreds of plaintiffs seek to recover damages from various banks and building societies. We were retained by the plaintiffs to provide expert advice, and accordingly conducted some research during 1992 into the actual and possible failure modes of automatic teller machine systems. This involved interviewing former bank employees and criminals, analysing statements from plaintiffs and other victims of ATM fraud, and searching the literature. We were also able to draw on experience gained during the mid-80's on designing cryptographic equipment for the financial sector, and advising clients overseas on its use.