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The multibillion-pound programme aims to cut credit and debit card fraud by 50% by requiring cardholders to authenticate purchases with a personal identification number instead of a signature.
The technology has been on trial in Northampton since mid-May and is due to be rolled out nationwide by December 2004.
So far, attention has been focused on the IT implications for retailers, such as installing new payment terminals and ensuring the new generation of debit and credit cards are authenticated quickly to avoid unnecessary delays at the checkout.
But the chip and Pin programme will still be a major IT project for banks, requiring modernisation of automated teller machines, extensive software testing and co-operation with other banks. Lloyds TSB has already updated its cash machine network to handle new chip cards and improve customer service.
If a cardholder types in the wrong Pin three times in a row at a retailer's point of sale terminal, their card will be locked. However, following Lloyd TSB's software upgrade - using technology from supplier ACI - its customers will be able to reactivate their cards at one of the bank's ATMs from an on-screen option.
The facility is currently only available in Northampton but will be rolled out to all high street banks later this year. All banks will have to upgrade their ATMs to handle chip cards.
The ATM chip and Pin facility will be of most use to credit cardholders who forget their Pin, said Steve Carter, technical consultant for Lloyds and head of its chip and Pin programme.
"Debit cardholders have been using their Pin for years, so card locking would not be an issue. But people do not generally know the Pin for their credit cards, partly because they are charged to withdraw money from an ATM."
Lloyds is also looking to develop technology to allow it to change the spending limits on cardholders' debit and credit card during transactions. A script messaging system authorises the limit change using information stored on the card microchip. Currently, cards can only be blocked.
Lloyds has invested about £3m in chip and Pin-related IT development so far. In addition to changes to its ATM network, the project required modifications to back-office systems to capture new information on card usage. About nine million debit cards and five million credit cards will be fitted with chips and rolled out from October.
Meanwhile, Barclaycard Merchant Services has signed a five-year deal worth £60m with payment specialist Ingenico to supply new chip and Pin-compliant payment terminals to its small to medium-sized customers.
Analysts said that although chip and Pin technology is relatively straightforward - it has been in operation in France for about 10 years - the number of organisations involved in its use could cause some problems.
"The main challenge for banks is that they do not own all of the infrastructure," said Duncan Brown, consulting director for analyst firm Ovum.
He warned that banks would need to ensure the new chip cards were recognised across the whole network, rather than just at each bank's cash machines.
Another potential tripwire is the card standards. Chip and Pin cards will be based on a technical standard by Europay/Mastercard Visa. But the cards use different operating systems, typically Java-based or proprietary systems.
Brown said banks will have to spend at least six months testing the chip and Pin systems which could result in a card being refused by a payment terminal. If the merchant then chooses to authenticate the card by swiping it using its magnetic stripe, the problem of skimming - copying card details onto a fraudulent card - could continue.
The main challenge for banks will lie in managing such a large upgrade and ensuring their infrastructure is compatible. Banks will also have to deal with other large compliance projects, such as the Basel 2 banking code on risk management.
With so much at stake, banks will want to avoid the early technical glitches that have marred so many online banking launches.
The multibillion-pound chip and Pin initiative aims to cut credit and debit card fraud by 50% by requiring cardholders to authenticate purchases with a personal identification number rather than a signature. The technology has been on trial in Northampton since mid-May.
About 125,000 chip cards have been issued to Northampton residents, with 500 stores accepting Pin payments.
By the end of the trial, a total of 200,000 cards will be in circulation, with 1,000 retailers accepting the cards. So far, feedback from retailers and consumers has been positive.
Chip and Pin technology is due to be rolled out across the UK by December 2004. Retailers will install new electronic point of sale terminals and industry experts have warned that this may require back-office upgrades.