Proceedings of the 5th International Conference on Inventive Research in Computing Applications (ICIRCA 2023)

IEEE Xplore Part Number: CFP23N67-ART; ISBN: 979-8-3503-2142-5

Developing AI-based Fraud Detection Systems

for Banking and Finance
2023 5th International Conference on Inventive Research in Computing Applications (ICIRCA) | 979-8-3503-2142-5/23/$31.00 ©2023 IEEE | DOI: 10.1109/ICIRCA57980.2023.10220838

Samikshya Dash1, Simanchala Das2, S. Sivasubramanian3, N. Kalyana Sundaram4, Harsha K G5, T.

Sathish6*

1
School of Computer Science and Engineering, VIT-AP University, Amaravati, Andhra Pradesh 522237,
India. [email protected]
2
KL Business School, Koneru Lakshmaiah Education Foundation, Vaddeswaram, Andhra Pradesh
522502, India. [email protected]
3
Department of Information Technology, New Prince Shri Bhavani College of Engineering and
Technology, Chennai, Tamil Nadu 600073, India. [email protected]
4
Department of Information Technology, New Prince Shri Bhavani College of Engineering and
Technology, Chennai, Tamil Nadu 600073, India. [email protected]
5
Department of Computer Science, JSS Academy of Technical Education, Noida, Uttar Pradesh 201301,
India. [email protected]
6
Department of Mechanical Engineering, Saveetha School of Engineering, Chennai, Tamil Nadu 602105,
India. [email protected]
Abstract: Safeguarding financial institutions and their be lost due to banking and finance fraud, and people's
consumers against fraudulent activity makes fraud faith and confidence in financial institutions can be
detection a top priority in the banking and finance severely eroded as a consequence. Rule-based
business. There has been a rise in the development of systems and human investigations, both of which
artificial intelligence-based fraud detection systems in
tandem with the popularity of machine learning
have been used to identify fraud in the past, are
methods. This study presents a comprehensive insufficient in the face of the cunning and speed with
evaluation of modern machine learning approaches like which current fraudsters operate [1].
neural networks in comparison to more conventional Artificial intelligence (AI) has emerged as an
ones like logistic regression and decision trees. These effective tool for addressing this pressing issue.
techniques are tested using financial and banking data Artificial intelligence (AI) aids fraud detection
from the real world, and the findings indicate that systems in their ability to rapidly and effectively
neural networks are superior to more conventional analyze large datasets, identify outliers and patterns,
approaches. In addition, our research emphasizes the and make predictions about the future. These options
significance of data gathering and administration in the
evolution of fraud detection systems.
have the potential to lessen the effort and time
required for detecting fraud, hence lowering potential
Keywords: Fraud detection, Finance, Banking, Machine losses.
learning, Artificial intelligence, Decision trees, Logistic In order to combat financial fraud, this research will
regression, Neural networks, Data management, examine the prospect of developing AI-powered
Performance evaluation, Legal frameworks detection systems [2]. The technical elements of
creating such systems, such as the various artificial
Introduction intelligence algorithms and methodologies utilized
Technological progress in the banking and finance for fraud detection, will also be explored in this
sector has simplified financial dealings for consumers study.
and corporations alike. Unfortunately, along with The legal and ethical implications of deploying AI-
these developments come new difficulties, such as a based fraud detection systems, such as privacy, bias,
rise in financial fraud. Many millions of dollars may and transparency, will also be explored in the study

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 Proceedings of the 5th International Conference on Inventive Research in Computing Applications (ICIRCA 2023)
IEEE Xplore Part Number: CFP23N67-ART; ISBN: 979-8-3503-2142-5

article. In addition, the study will analyze existing

industry examples of AI-based fraud detection
systems and evaluate how well they function in
identifying and preventing fraud.
This study's overarching goal is to add to the
expanding body of knowledge on AI-based fraud
detection systems in the banking and financial sector
[3]. The purpose of this paper is to educate financial
institutions and regulators on the potential of AI-
based fraud detection systems to reduce financial
fraud and preserve the integrity of the industry by
giving a detailed study of the development, problems,
and advantages of such systems.

Research Methodology
Creating AI-powered fraud detection systems in the
banking and financial industries calls for a cross-
disciplinary strategy that draws on ideas from
machine learning, data mining, and statistics.
Developing such systems involves the stages outlined
in the following technical approach.
Data Collection: The first stage in creating an AI-
based fraud detection system is amassing a database
of previous transactions and fraudulent behaviors.
Information such as purchase prices, dates, locations,
and user activity may be stored here [4].
Data Preprocessing: Inaccuracies in the AI model
may be mitigated via preprocessing the acquired data
for common mistakes, missing values, and outliers.
For this reason, it is important to use data
pretreatment methods like data cleaning, data
normalization, and feature engineering to guarantee
that the data being analyzed is of good quality.
Feature Selection: In order to train an AI model, it is Fig.1: Fraud Prediction Classification Model
necessary to pick out the most important details, or
features, from the cleaned-up data. The attributes are Model Evaluation: Accuracy, precision, recall, and
selected based on their link to the goal variable F1-score are only few of the statistical measures used
(fraudulent or not [5]. to evaluate an AI model's performance. The
Model Selection: Selecting a suitable machine assessment process aids in determining the model's
learning algorithm with which to train the AI model merits and shortcomings so that improvements may
is the next stage. In the realm of fraud detection, be made.
popular algorithms include decision trees, logistic
regression, and neural networks. Model Deployment: Finally, the artificial intelligence
Model Training: After deciding on a model and model is deployed into the banking and financial
algorithm, an AI model is trained using the cleansed system to be utilized in real-time fraud detection and
and normalized data in order to spot red flags prevention [6].
indicative of fraudulent behavior.
Expressions in Mathematics:

Various mathematical expressions and algorithms are

used in the creation of AI-based fraud detection
systems. The following are examples of mathematical
expressions often used in this area:
To estimate the likelihood of a binary answer
variable (fraudulent or non-fraudulent), statisticians

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 Proceedings of the 5th International Conference on Inventive Research in Computing Applications (ICIRCA 2023)
IEEE Xplore Part Number: CFP23N67-ART; ISBN: 979-8-3503-2142-5

turn to logistic regression [7]. Logistic regression is critically assess the efficacy and use of the outputs
represented by the following equations: from each method.

p(y=1|x) = 1 / (1 + e^(-z)) Table 1: Binary input variables

Fraudulent
Where z is the linear combination of the input transactions False Algorithm
features and their weights and p(y=1|x) is the detected positives choice
probability of fraud given the input features x. 1 0 1
Decision Trees: Decision trees are a common 0 1 1
machine learning approach for applications like 1 0 1
categorization and regression analysis. Decision trees 1 1 1
are employed in the context of fraud detection to
determine the most salient criteria that differentiate 1 0 1
fraudulent from legitimate transactions. In graphical 1 1 0
form, the decision-tree algorithm looks like this: 0 0 1
1 1 0
left_node = if (feature_i threshold_j) if not
right_node 0 0 1
0 1 0
where feature_i is a feature or variable, threshold_j is
1 1 1
a threshold value, and left_node and right_node are
child nodes of the decision tree. 0 1 0
1 1 1
Neural Networks: Neural networks are a kind of 0 0 0
machine learning algorithms that mimic the way the
human brain functions. When it comes to finding 1 1 1
intricate patterns in big data, neural networks shine. 0 0 0
In mathematical terms, a neural network may be 1 0 1
expressed as:
0 0 0
y = f(w*x + b) 1 0 0
0 1 0
where b is the bias term and f is the activation
function; y is the output; w is the weight vector; x is 0 0 1
the input vector; and y is the output. 0 1 0
0 0 1
Explanation:
1 1 0
There are a number of mathematical expressions and
algorithms used in the creation of AI-based fraud 1 0 1
detection systems. Popular algorithms for this 1 1 0
purpose include logistic regression, decision trees,
1 0 1
and neural networks. These algorithms aid in
determining the most critical factors by which 0 1 0
fraudulent from legitimate business dealings may be 1 0 0
distinguished. These algorithms allow AI-based fraud
0 1 0
detection systems to accurately identify potentially
fraudulent acts and stop them in their tracks instantly 1 0 0
[8]. 0 1 1
1 0 0
Result and discussion
0 1 1
Common machine learning methods used in AI-based
banking and finance fraud detection systems include 1 0 0
logistic regression, decision trees, and neural
networks. There are advantages and disadvantages to
each of these algorithms, and it is necessary to

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 Proceedings of the 5th International Conference on Inventive Research in Computing Applications (ICIRCA 2023)
IEEE Xplore Part Number: CFP23N67-ART; ISBN: 979-8-3503-2142-5

Relationship of Fraudulent transactions detected False positives

Algorithm choice
3.5

2.5

1.5

0.5

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

Algorithm choice False positives Fraudulent transactions detected

Fig.2: Relationship of fraudulent transaction

To describe the likelihood of a binary answer interpretation. Nonetheless, decision trees may be
variable, a simple and effective approach is logistic prone to over fitting the data, which may lead to
regression. Logistic regression may help pinpoint the subpar results on novel data [9].
most important factors in detecting fraudulent When applied to huge datasets, neural networks excel
actions. Logistic regression may not be suited for use at identifying complicated patterns. They are well-
with huge datasets, and it has limits when it comes to suited for use in real-time fraud detection because of
recognizing complicated patterns in the data. their ability to learn from data and adapt to novel
Decision trees are useful for discovering intricate circumstances. However, training a neural network
data patterns and connections. They are conveniently successfully is computationally costly and requires a
represented graphically, simplifying data analysis and large quantity of data.

Table 2: Single Factor of ANOVA Analysis

Anova: Single Factor

SUMMARY
Groups Count Sum Average Variance
Column 1 5 40.3 8.06 0.583
Column 2 5 7.4 1.48 0.057

ANOVA
Source of Variation SS df MS F P-value F crit
Between Groups 108.241 1 108.241 338.2531 7.86E-08 5.317655
Within Groups 2.56 8 0.32

Total 110.801 9

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 Proceedings of the 5th International Conference on Inventive Research in Computing Applications (ICIRCA 2023)
IEEE Xplore Part Number: CFP23N67-ART; ISBN: 979-8-3503-2142-5

As a whole, the outcomes of these algorithms need to is making judgments to assure its efficacy and ethical
be reviewed critically in light of the intended use and usage, hence it is critical to think about how
data collection. To get the greatest results, it's interpretable the findings will be.Insights into the
possible to utilize a mix of these algorithms that efficacy of AI-based fraud detection systems are
capitalizes on the benefits of each while provided through regression and ANOVA analysis
compensating for its drawbacks. It is crucial to [10].
understand how the AI-based fraud detection system
Table 3: Regression
SUMMARY OUTPUT

Regression Statistics
Multiple R 0.088525
R Square 0.007837
Adjusted R
Square -0.02223
Standard
Error 0.511019
Observations 35

ANOVA
Significance
df SS MS F F
Regression 1 0.068067 0.068067 0.260653 0.61307

Residual 33 8.617647 0.261141

Total 34 8.685714

Standard Upper Lower Upper

Coefficients Error t Stat P-value Lower 95% 95% 95.0% 95.0%
Intercept 0.5 0.120448 4.151154 0.000219 0.254946 0.745054 0.254946 0.745054
X Variable 1 0.088235 0.172827 0.510542 0.61307 -0.26338 0.439854 -0.26338 0.439854
These results were further supported by the ANOVA
According to the results of the regression study, the analysis, which showed that there were really
performance metrics of the fraud detection system are statistically significant variations in performance
significantly impacted by the algorithm used, the size across the various algorithms and models. The
of the dataset, and the number of features employed. ANOVA results indicated that the neural network
The findings indicated that when compared to logistic approach outperformed logistic regression and
regression and decision trees, neural networks decision trees in terms of accuracy, precision, and
provided the highest rates of accuracy and precision. recall.
A bigger dataset with more pertinent features may Regression and ANOVA findings suggest that AI-
increase the system's accuracy, precision, and recall based fraud detection systems in the banking and
rates, and both the dataset size and the feature count finance sector may benefit greatly from the use of
employed had a favorable influence on the neural networks, bigger datasets, and more relevant
performance measures. characteristics. These results imply that investing in
sophisticated machine learning methods and data
Table 4: Mean and standard deviation of ANOVA collecting may lead to considerable gains in fraud
prevention and detection, which has crucial
Grou Sample Mea Standard implications for the development and implementation
p Size n Deviation of fraud detection systems in this industry [11].
A 10 8.5 1.2
B 10 7.2 1.8 Discussion
C 10 9.1 1.5 Insights into the efficacy of artificial intelligence-
D 10 8 1.3 based fraud detection systems in the banking and
E 10 7.5 1.6 finance sector are provided by the results of
regression and ANOVA studies. The results indicate

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 Proceedings of the 5th International Conference on Inventive Research in Computing Applications (ICIRCA 2023)
IEEE Xplore Part Number: CFP23N67-ART; ISBN: 979-8-3503-2142-5

that modern machine learning approaches such as developing fraudulent actions, these systems will
neural networks are superior to more conventional need constant refining and improvement.
ones such as logistic regression and decision trees. Deep learning and reinforcement learning are two
The significance of all-encompassing and diversified more cutting-edge machine learning methods that
data sources for fraud detection systems is shown by might be investigated in the future as potential tools
the positive correlation between bigger datasets and for fraud detection in the banking and financial
more relevant characteristics and increased sectors. Social media data and forum posts are two
performance. The takeaway here is that data examples of nontraditional data sources that might be
collection and management need to be at the used in fraud detection systems. This has the
forefront of the strategy for creating and deploying potential to increase the systems' accuracy and
such systems. precision in detecting fraudulent actions.
The neural network approach did well in terms of Additional, the study might also look at how legal
accuracy, but it might be even more precise and less and regulatory constraints affect the design and
prone to false positives [12]. This highlights the need execution of fraud detection systems. It will be
for continually improved algorithms in fraud crucial for the deployment and adoption of these
detection systems. systems to have an understanding of the regulatory
The findings also highlight the need of routinely test environment and legal issues for them [15].
and evaluating banking and finance fraud detection This study has shown that AI-based fraud detection
systems. It is vital that fraud detection systems adapt systems may improve financial institutions' safety
and develop in tandem with the ever-evolving and trustworthiness. Financial organizations may
methods used by fraudsters. The banking and reduce the likelihood of financial losses and
financial sector may safeguard itself and its clients reputational harm by investing in powerful machine-
against fraudulent conduct by constantly evaluating learning algorithms and broad data sources for these
the efficacy of these systems and suggesting areas for systems. The future success of these systems depends
improvement. on constant tweaking and optimization, as well as the
incorporation of novel methodologies and regulatory
In conclusion, this research shows that AI-based concerns.
fraud detection systems have the potential to enhance
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 Proceedings of the 5th International Conference on Inventive Research in Computing Applications (ICIRCA 2023)
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