The chips are sophisticated and powerful enough to setup an SSL/TLS session to the bank if needed. Just like with SSL/TLS, if it's designed correctly, intercepting the traffic between the card and POS/ATM is useless.
I haven't been able to find very much on this in a few evenings that I searched for info on it, but from what I've been able to find I'm quite sure that it's possible to do. The chips give a boolean response as to whether the PIN number is correct and lock themselves after 3 attempts. Combined with the knowledge that 6 pins (=6 parallel bits) are used for 4 digit PIN numbers (log(10^4)/log(2)=14bits), you can deduce that it must have at least persistent storage and computational capabilities. A complete Von Neumann machine. This makes it feasible to implement algorithms like RSA and AES (asymmetric and symmetric encryption) on the chips. The POS/ATM then provides power and a connection to the desired bank, and all should be fine.
I don't really think they are that good to connect to the bank directly, but the idea that the chip is capable of this kind of crypto makes me feel better than with magnetic strips.
They are "sort of" connecting to the bank - the idea is that the card issues an authorisation token w. the amount and other info, signs it with the private key, and then the merchant sends it to the bank which may approve or deny the transaction.
I haven't been able to find very much on this in a few evenings that I searched for info on it, but from what I've been able to find I'm quite sure that it's possible to do. The chips give a boolean response as to whether the PIN number is correct and lock themselves after 3 attempts. Combined with the knowledge that 6 pins (=6 parallel bits) are used for 4 digit PIN numbers (log(10^4)/log(2)=14bits), you can deduce that it must have at least persistent storage and computational capabilities. A complete Von Neumann machine. This makes it feasible to implement algorithms like RSA and AES (asymmetric and symmetric encryption) on the chips. The POS/ATM then provides power and a connection to the desired bank, and all should be fine.
I don't really think they are that good to connect to the bank directly, but the idea that the chip is capable of this kind of crypto makes me feel better than with magnetic strips.