CREDIT CARD
FRAUD DETECTION
USING AI/ML
Leveraging AI/ML for Enhanced
Security in Financial Transactions
Presented by-
Mohd. Usman
Research Scholar
Department of Computer Science
University of Lucknow
Credit Card Fraud Overview
Credit card fraud involves unauthorized use of credit cards to obtain goods,
services, or funds. It affects both individuals and businesses, leading to financial
losses and compromised personal information. Some common types of credit card
fraud are:
Card Not Present Fraud:
- Occurs when the physical card isn’t present during a transaction (common in
online or over-the-phone purchases). In 2023, card not present fraud accounted
for an estimated $9.49 billion in losses.
Account Takeover Fraud:
- Fraudsters gain access to a victim’s account to make unauthorized transactions. In
2023, account takeover attacks increased by 354% year-over-year, resulting in
almost $13 billion in losses
Card Skimming:
- Fraudsters use devices to
capture card information from
ATMs or point-of-sale terminals.
Card skimming costs
consumers and financial
institutions over $1 billion
annually.
Phishing Scams:
- Trick victims into providing card
information through fake
emails, texts, or websites
Challenges in Traditional
Fraud Detection
Rule-Based Systems Limitations:
- Traditional fraud detection methods often rely on predefined rules. While
effective to some extent, these systems have limitations:
Rigidity: Rule-based models excel at detecting known fraud patterns but
struggle to adapt to new or evolving tactics. Fraudsters continuously refine
their strategies, rendering fixed rules less effective.
Maintenance Overhead: Maintaining and enhancing rule sets becomes
complex and time-consuming as fraud techniques evolve
High False-Positive Rates:
- False positives occur when legitimate transactions are incorrectly flagged as potentially
fraudulent.
- High false-positive rates lead to lost revenue, reputational damage, and wasted resources. Risk
management teams must strike a balance between fraud prevention and customer satisfaction
Adaptive Nature of Fraudsters:
- Fraudsters constantly alter their approaches. As we tighten security systems, they find new
ways to attack.
- Continuous advancements in fraud prevention are essential to stay ahead of their evolving
tactics.
Scalability Issues with Increasing Transactions:
- As digital transactions grow exponentially, manual monitoring becomes impractical. The sheer
volume overwhelms capacity, leading to slower processing times and potential oversight5.
- AI-driven fraud detection systems offer scalability without proportional increases in staffing.
They optimize efficiency as transaction volumes increase
Machine Learning Techniques
for Fraud Detection
Supervised Learning for Fraud Detection
- Supervised learning involves training models using labeled data—historical records annotated as
either “fraudulent” or “non-fraudulent.”
1. Training Data:
- The model learns patterns from this labeled data.
2. Classification Models:
- Decision Trees: These hierarchical structures split data based on features to classify transactions.
- Random Forest: An ensemble of decision trees that improves accuracy.
- Support Vector Machines (SVM): Effective for binary classification tasks.
3. Predictions:
- Once trained, the model can predict whether a new transaction is fraudulent or not.
- It’s like having a digital detective that learned from past cases and can now identify suspicious
behavior.
Unsupervised Learning for Fraud Detection
- Unsupervised learning doesn’t rely on labeled data. Instead, it searches for
patterns and anomalies within raw data. Key points:
1. Anomaly Detection:
- Unsupervised models identify unusual patterns without predefined labels.
- Techniques like clustering (grouping similar transactions) and Isolation Forest
(isolating anomalies) are commonly used.
2. Handling Imbalanced Data:
- Fraudulent transactions are rare compared to legitimate ones. Unsupervised
learning helps address this imbalance.
Deep Learning in Fraud Detection
- Deep learning, a subset of machine learning, leverages neural networks to process complex
data.
1. Neural Networks:
- Deep learning models, such as Convolutional Neural Networks (CNNs), Recurrent Neural
Networks (RNNs), and Long Short-Term Memory (LSTM) networks, excel at capturing intricate
patterns.
- They’re particularly useful when dealing with unstructured data (e.g., text, images).
2. Feature Extraction:
- Deep learning models automatically learn relevant features from raw data.
- For example, an LSTM can analyze sequences of transactions to detect subtle fraud patterns.
3. Reducing False Positives:
- Deep learning helps minimize false alarms (false positives) by improving precision.
- Fewer false positives mean less inconvenience for legitimate users.
Using Machine Learning for
Fraud Detection
Implementing machine learning for fraud detection solutions in the retail sector
follows a structured approach that can be adapted to various fraud schemes
encountered by businesses.
1) Data Collection and Preprocessing
- Collect relevant data sources, including transaction records, customer information,
product details, and historical fraud data. Preprocess the data to ensure it is
structured and labeled appropriately. For supervised learning, label legitimate
transactions as “good” and fraudulent activities as “bad.” Unsupervised learning
techniques can also be applied to discover patterns in unstructured data.
2) Feature Extraction
- Extract critical parameters from the data indicating fraudulent behavior in the retail sector.
These parameters may include:
a) Transaction frequency and patterns
b) Transaction amounts
c) Product categories and purchase history
d) Customer behavior and account activity
e) Geographical information such as IP addresses and shipping addresses
3) Rule Definition and Management
- Analyze the extracted features to define rules that identify potential fraudulent activity.
These rules range from simple thresholds (e.g., huge transactions) to complex patterns (e.g.,
repeated returns followed by high-value purchases). Rules may involve multiple parameters
to enhance accuracy and reduce false positives. Regularly reviewing and tuning rules are
essential to adapting to evolving fraud tactics.
4) Model Training and Evaluation
- Train machine learning models using labeled data to identify patterns of
fraudulent behavior. Evaluate the performance of the models using validation
data sets and adjust parameters as needed to optimize accuracy and minimize
false positives. Continuous monitoring and refinement of the models are
necessary to keep pace with new fraud patterns and changing retail dynamics.
5) Integration and Deployment
- Integrate the trained machine learning models into the retail organization’s
fraud detection system. Ensure seamless interoperability with existing
infrastructure and workflows. Provide ongoing support and maintenance to
monitor model performance, address emerging fraud threats, and fine-tune
algorithms as necessary
Challenges and Limitations
1. Data Privacy Concerns:
- Issue: AI and ML algorithms heavily rely on user data, which raises concerns about privacy and
surveillance.
- Impact: With the increasing amount of personal information collected, there is a risk of misuse or
unauthorized access.
- Solution: Responsible data handling practices, anonymization, and transparency are essential to
address these concerns.
2. Model Interpretability Issues:
- Issue: Complex models (like deep learning or gradient boosting) are often referred to as “black-box”
models because they are too intricate for human understanding.
- Impact: Lack of interpretability hinders our ability to explain why the model makes specific
predictions.
- Solution: Researchers are actively working on methods to make unexplainable models more
interpretable. Techniques like Lime and Shapley values help identify input variable importance and
add an interpretation to model predictions
3. Need for Continuous Learning and Adaptation:
- Issue: Traditional machine learning approaches face limitations in adapting to new
information and maintaining relevance over time.
- Impact: Without continuous learning, models become outdated and less effective in
dynamic environments.
- Solution: Implement lifelong learning strategies, incremental updates, and adaptive
algorithms to keep AI systems sharp and relevant56.
4. Balancing False Positives and False Negatives:
- Issue: In classification tasks, we often encounter trade-offs between false positives (FP)
and false negatives (FN).
- Impact: Optimizing for one metric (e.g., precision or recall) can lead to suboptimal
performance in the other.
- Solution: Choose evaluation metrics based on the specific task, cost of misclassifications,
and dataset balance. For imbalanced datasets, consider precision-recall trade-offs
Future Trends in AI/ML for Fraud Detection
1. Evolution of AI/ML Techniques
Generative AI: This cutting-edge approach
revolutionizes fraud prevention. By combining
adaptive learning, large dataset handling,
improved anomaly detection, and reduced false
positives, generative AI enhances our ability to stay
ahead of fraudsters.
Explainable AI (XAI): Researchers are working on
making complex AI models more interpretable. XAI
ensures that we understand why a model makes
specific predictions, which is crucial for trust and
accountability.
Hybrid Models: Combining different ML
techniques—such as neural networks, decision
trees, and clustering—allows us to leverage their
strengths and mitigate their weaknesses
2. Integration of Blockchain and AI
- Blockchain and AI together create a powerful synergy for fraud prevention:
- Blockchain Security: Blockchain’s decentralized and tamper-resistant
ledger ensures that once data is recorded, it remains unalterable. This
inherent security makes it an optimal choice for reinforcing financial
systems against cyber threats and fraudulent activities.
- AI Algorithms in Smart Contracts: Smart contracts, a distinctive
feature of blockchain, can be enhanced by integrating AI algorithms. These
contracts automate and enforce agreements, reducing reliance on
intermediaries and minimizing human error.
3. Predictive Analytics and Real-Time Fraud Detection
- Predictive analytics plays a pivotal role in detecting and preventing fraud:
- Proactive Identification: Predictive analytics goes beyond reacting to
fraud—it proactively identifies potential threats. By analyzing historical
data and patterns, it predicts future outcomes, empowering financial
institutions to take immediate action5.
- Real-Time Assessment: Real-time fraud detection assigns risk scores to
transactions instantly. High-risk transactions are flagged for review or
blocked, swiftly stopping fraudsters and protecting financial assets
