Preprints202406 1756 v1
Preprints202406 1756 v1
doi: 10.20944/preprints202406.1756.v1
Keywords: Fraud Detection; Machine Learning; Random Forest; Financial Risk Management
Copyright: This is an open access article distributed under the Creative Commons
Attribution License which permits unrestricted use, distribution, and reproduction in any
medium, provided the original work is properly cited.
Preprints.org (www.preprints.org) | NOT PEER-REVIEWED | Posted: 25 June 2024 doi:10.20944/preprints202406.1756.v1
Disclaimer/Publisher’s Note: The statements, opinions, and data contained in all publications are solely those of the individual author(s) and
contributor(s) and not of MDPI and/or the editor(s). MDPI and/or the editor(s) disclaim responsibility for any injury to people or property resulting
from any ideas, methods, instructions, or products referred to in the content.
Article
* Correspondence: [email protected]
Abstract: This article explores the application of machine learning techniques, specifically focusing on
ensemble methods like Random Forests, for detecting fraudulent activities in digital financial transactions.
Highlighting the evolution from traditional statistical approaches to modern machine learning models, it
underscores the effectiveness of Random Forests in handling the inherent challenges of imbalanced datasets
typical in fraud detection scenarios. Using a Kaggle dataset of credit card transactions, the study optimizes
Random Forest parameters through rigorous parameter tuning, achieving significant improvements in model
performance metrics such as Area Under the Curve (AUC). The findings underscore the critical role of machine
learning in enhancing fraud detection capabilities, emphasizing the ongoing evolution and future potential of
these methodologies in financial risk management.
Keywords: fraud detection; machine learning; random forest; financial risk management
1. Introduction
The risk management system is a broad and complex topic involving a body of knowledge
covering many aspects. Its construction process is not uniform but according to different business
structures for “targeted” shape from the perspective of industry division, standard credit card
industry, cash loan industry, third-party payment/transaction industry, auto finance industry, and
financial leasing industry. From the perspective of the division of the end audience, it can be divided
into B end (to B) and C end (to C). With the continuous improvement of national policy supervision,
especially in the financial industry, the importance of risk compliance has increased
sharply.[1]Therefore, the construction of the risk management sub-system can be divided into risk
prevention and control and risk compliance.
The division from different angles is to focus better, but it does not mean that these are
independent, divided states. On the contrary, it can achieve better integration, make full use of
limited risk control resources, and put forward higher requirements for the compatibility of the entire
risk system. The risk management system of online credit products includes modules such as anti-
fraud, credit approval, in-loan management, and post-loan management. [2]In the process of carrying
out business, banks and other financial institutions focus on the structure and constantly improve the
strategies and models of each link so that the product business can better meet the needs of the
Internet credit scene, solve the pain points, and difficulties of risk control of banks and other financial
institutions, and constantly improve the asset quality on the premise of balancing the asset scale.
Anti-fraud risk management covers customer credit and money applications for Internet
revolving credit products. Among them, the leading fraud prevention in the credit application
process includes non-personal applications, false information, gang fraud, etc. The prominent fraud
cases to be prevented in the application of funds include account theft, account cracking, and
dragging the library into the library. In this complex risk management environment, machine
learning-driven fraud detection systems have become a powerful tool that can provide effective fraud
prevention and control at all process stages and improve financial institutions’ overall risk
management capabilities.
2. Related Work
of decisions. These studies drive innovation in risk management techniques and provide businesses
and organizations with more reliable tools and methods to deal with complex risk environments.
3. Efficiency. Machines can take over the repetitive work of routine tasks and human fraud
analysis, and experts will be able to spend their time making more advanced decisions.
Payment fraud detection is the most common type of fraud solved by artificial intelligence (AI).
It is as varied as the fraudsters can imagine. [10]However, here are some of the most common types
of payment fraud: lost card, stolen card, fake card, stolen card ID, and card not received. The recent
emergence of cards with chips (EMV cards) has helped reduce card fraud in Europe but not in the
United States, where the elimination process for magnetic stripe cards has been prolonged.
Cardless transactions come in many forms. After attacking the user by phishing, contacting their
mobile provider, and breaking into the account online in a way that allows the criminals to gather
enough card details, the fraudster orders goods or loans. [11]A loan scam may occur if someone
contacts you to offer a loan on unrealistically good terms, the lender does not provide a check
confirming the loan, the lender asks for bank details or an advance payment, or the company pretends
to be from a particular country, but the number is international.
Furthermore, fraud models can be solved by supervised and unsupervised machine learning
algorithms. A traditional classification algorithm is used. In the second case, we can use anomaly
detection techniques. The use of neural networks is also effective, but it requires a lot of training data,
with two types of data points in equal numbers: abnormal and normal. However, in the case of fraud
detection, there is always a lack of balanced data sets.
A robust risk management framework is crucial for the financial industry to prevent crises by
identifying and mitigating risks early. [13]Effective risk management involves analyzing transaction
data, verifying customer information, conducting cross-account analyses, and monitoring network
risks to ensure the security of financial operations.
Given the continuous evolution of fraud detection methods and the critical role of risk
management, the next section will explore the methodology for developing a machine learning-
driven fraud detection model. This model aims to address the complexities and dynamic nature of
fraudulent activities, leveraging advanced ML techniques to enhance the accuracy and efficiency of
fraud prevention in financial institutions.
3. Methodology
In digital financial payments, accurately predicting user payment behavior is crucial to help
financial institutions better understand user needs, manage risks, and optimize services. Ensemble
learning is not a single machine learning algorithm; it integrates multiple base learners (i.e., weak
learners), eventually forming a strong learner. These base learners should have a degree of predictive
accuracy and diversity; that is, they differ in the learning process. Decision trees and neural networks
are commonly used as base learners.
2. In the anti-fraud field, the number of samples is usually tiny, and the fraud risk of each sample
is different. In this case, traditional machine learning methods may not accurately identify fraud due
to insufficient data volume. Therefore, it is recommended that ensemble learning methods such as
random forest be used to improve the accuracy of recognition.
transactions made by European credit cardholders in September 2013. It contains a total of 284,807
transactions, of which 492 are fraudulent.
This study aims to explore and compare the performance of three commonly used machine
learning models: XGBoost, decision tree, and random forest on financial digital payment datasets.
Therefore, by comparing the classification prediction performance of these three models on financial
digital payment datasets, we aim to determine which model is most suitable for digital payment
behavior prediction.
This dataset is commonly used in machine learning research for fraud detection due to its
imbalance between every day and fraudulent transactions, making it challenging yet representative
of real-world scenarios.
3.2.1.1. Notes:
• Purpose: The dataset aims to study and predict fraudulent credit card transactions to enhance
the security of payment systems and user trust.
• Features: The transformed dataset contains 29 principal component columns derived from
PCA, representing linearly independent components of the original data.
• Feature Examples: These components may encapsulate various transaction-related factors such
as transaction amount, time, location, and other transaction details.
By presenting the dataset characteristics in this tabular format, readers can easily grasp the
structure and purpose of the data used in your study. This approach clarifies the use of PCA for
dimensionality reduction and emphasizes the focus on predicting fraudulent transactions to improve
financial system security and user confidence.
employed to balance the dataset for training. The primary objective was to enhance model
performance by tuning key parameters such as estimators, adept, and min_samples_split.
This summary encapsulates the study’s key outcomes, emphasizing the impact of parameter
tuning on improving the RF model’s ability to detect fraudulent transactions in financial digital
payment systems.
4. Conclusion
With the rapid development of financial technology and the digital transformation of financial
services, applying machine learning in financial risk management is particularly important and
necessary. Especially in identifying and preventing fraudulent activities, traditional statistical
methods have been unable to meet the increasingly complex fraud detection needs. Machine learning
models, especially integrated learning methods like Random Forest, can reduce the risk of fraud faced
by financial institutions by learning patterns and trends in historical data to identify and respond to
ever-changing fraud automatically.
However, the current application of machine learning in finance still needs some challenges and
limitations. For example, the data imbalance problem leads to skew in the model training process,
limiting the identification accuracy of a few categories (fraudulent transactions). Future research can
focus on solving these problems, exploring more complex and efficient machine learning models, and
combining techniques such as deep learning and natural language processing further to improve the
performance of financial fraud detection systems.
In addition, as regulatory requirements and consumer expectations rise, financial institutions
are increasingly focused on risk management and security. Machine learning can help institutions
respond quickly to potential fraud in real-time transactions and optimize overall risk management
strategies through a data-driven approach. As a result, foreseeable future developments in the
financial sector include more efficient risk prediction and management through enhanced learning
and real-time data processing technologies, as well as the use of emerging technologies such as
blockchain and secure computing to ensure the security and trust of financial information.
In summary, the application of machine learning in financial risk management is promising, but
continuous innovation and progress are needed to meet the changing financial environment and
technological challenges. Through interdisciplinary collaboration and technological innovation, we
can expect more significant progress and achievements in fraud detection and risk management in
the future.
References
1. Power, Michael. “The risk management of everything.” The Journal of Risk Finance 5.3 (2004): 58-65.
2. Ahmed, Ammar, Berman Kayis, and Sataporn Amornsawadwatana. “A review of techniques for risk
management in projects.” Benchmarking: an international journal 14.1 (2007): 22-36.
3. Hopkin, P. (2018). Fundamentals of risk management: understanding, evaluating and implementing effective risk
management. Kogan Page Publishers
4. Rasmussen, J. (1997). Risk management in a dynamic society: a modeling problem. Safety Science, 27(2-3),
183-213.
5. Abdallah, Aisha, Mohd Aizaini Maarof, and Anazida Zainal. “Fraud detection system: A survey.” Journal
of Network and Computer Applications 68 (2016): 90-113.
6. Ogwueleka, F. N. (2011). Data mining application in credit card fraud detection system. Journal of
Engineering Science and Technology, 6(3), 311-322.
7. Song, Jintong, et al. “LSTM-Based Deep Learning Model for Financial Market Stock Price Prediction.”
Journal of Economic Theory and Business Management 1.2 (2024): 43-50.
8. Cheng, Qishuo, et al. “Monetary Policy and Wealth Growth: AI-Enhanced Analysis of Dual Equilibrium in
Product and Money Markets within Central and Commercial Banking.” Journal of Computer Technology
and Applied Mathematics 1.1 (2024): 85-92.
9. Li, Huixiang, et al. “AI Face Recognition and Processing Technology Based on GPU Computing.” Journal
of Theory and Practice of Engineering Science 4.05 (2024): 9-16.
10. Qin, Lichen, et al. “Machine Learning-Driven Digital Identity Verification for Fraud Prevention in Digital
Payment Technologies.” (2024).
11. Choudhury, M., Li, G., Li, J., Zhao, K., Dong, M., & Harfoush, K. (2021, September). Power Efficiency in
Communication Networks with Power-Proportional Devices. In 2021 IEEE Symposium on Computers and
Communications (ISCC) (pp. 1-6). IEEE.
Preprints.org (www.preprints.org) | NOT PEER-REVIEWED | Posted: 25 June 2024 doi:10.20944/preprints202406.1756.v1
12. Lakshmi, S. V. S. S., & Kavilla, S. D. (2018). Machine learning for credit card fraud detection system.
International Journal of Applied Engineering Research, 13(24), 16819-16824.
13. Qian, K., Fan, C., Li, Z., Zhou, H., & Ding, W. (2024). Implementation of Artificial Intelligence in Investment
Decision-making in the Chinese A-share Market. Journal of Economic Theory and Business Management,
1(2), 36-42.
14. Qi, Y., Wang, X., Li, H., & Tian, J. (2024). Leveraging Federated Learning and Edge Computing for
Recommendation Systems within Cloud Computing Networks. arXiv preprint arXiv:2403.03165.
15. Wang, Yong, et al. “Machine Learning-Based Facial Recognition for Financial Fraud Prevention.” Journal
of Computer Technology and Applied Mathematics 1.1 (2024): 77-84.
16. Wang B, Lei H, Shui Z, et al. Current State of Autonomous Driving Applications Based on Distributed
Perception and Decision-Making[J]. 2024.
17. Chen, Zhou, et al. “Application of Cloud-Driven Intelligent Medical Imaging Analysis in Disease Detection.”
Journal of Theory and Practice of Engineering Science 4.05 (2024): 64-71.
18. Fawcett, T., & Provost, F. (1997). Adaptive fraud detection. Data mining and knowledge discovery, 1(3), 291-
316.
19. Yu, D., Xie, Y., An, W., Li, Z., & Yao, Y. (2023, December). Joint Coordinate Regression and Association For
Multi-Person Pose Estimation, A Pure Neural Network Approach. In Proceedings of the 5th ACM
International Conference on Multimedia in Asia (pp. 1-8).
20. Bolton, R. J., & Hand, D. J. (2002). Statistical fraud detection: A review. Statistical science, 17(3), 235-255.
21. Xuan, S., Liu, G., Li, Z., Zheng, L., Wang, S., & Jiang, C. (2018, March). Random forest for credit card fraud
detection. In 2018 IEEE 15th International Conference on networking, sensing, and Control (ICNSC) (pp. 1-6).
IEEE.
Disclaimer/Publisher’s Note: The statements, opinions and data contained in all publications are solely those
of the individual author(s) and contributor(s) and not of MDPI and/or the editor(s). MDPI and/or the editor(s)
disclaim responsibility for any injury to people or property resulting from any ideas, methods, instructions or
products referred to in the content.