TOPIC: Fraud Detection in Banking and

Ecommerce through Machine Learning

Fazeel Adnan 22F-3208

Ali Raza 22F-3235
Literature Review
Machine Learning & Data Mining Techniques in Fraud
Detection
Fraud detection has been a widely researched area, with studies covering various
detection techniques across different industries. The existing literature can be
categorized into general fraud detection reviews, domain-specific fraud detection
studies, and machine learning-based approaches.
Domain-Specific Fraud Detection Studies
Several studies provide an overview of fraud detection techniques and their
applications. Unam et al. (2023) conducted a comprehensive review of
automated fraud detection methods, categorizing them into supervised,
unsupervised, and hybrid approaches. Their study not only formalizes major
fraud types but also presents alternative solutions tailored to different industries.
Similarly, Amir and Hamid (2014) reviewed fraud detection literature and
identified five key fraud types: credit card fraud, telecom fraud, health insurance
fraud, auto insurance fraud, and online auction fraud. However, their study does
not follow a systematic review methodology and only covers literature from 1994
to 2014, potentially limiting its relevance to recent advancements.
Some studies focus on fraud detection within specific industries. Adewumi and
Akinyelu (2021) conducted a systematic review of financial fraud detection using
the Kitchenham approach, covering research from 2010 to 2021. Their study
emphasizes the role of machine learning techniques in identifying fraudulent
financial transactions. Similarly, Ahmed et al. (2018) reviewed anomaly detection
methods applied to financial fraud detection, highlighting the effectiveness of
advanced statistical and AI-driven models.
Credit card fraud is one of the most extensively reviewed fraud types in the
literature. Sorournejad et al. (2022) analyzed the misuse of supervised and
unsupervised techniques in credit card fraud detection and provided
recommendations for future researchers. Their study highlights the increasing
sophistication of fraud tactics, which challenges the robustness of existing
detection models.
Another significant research area is the application of machine learning and data
mining techniques in fraud detection. Pourhabibi et al. (2019) explored graph-
based anomaly detection, focusing on the relationships between different data
points to identify fraudulent patterns. Additionally, Aziz and Ghous (2021)
reviewed machine learning classification methods, assessing their effectiveness
in detecting fraudulent transactions. These studies provide critical insights into
the strengths and limitations of various fraud detection models.

Credit Card Fraud Detection

To prevent fraudulent transactions and enhance fraud detection accuracy,
several studies have explored different machine learning techniques. Halvaiee
and Akbari (2014) introduced an AIS-based fraud detection model (AFDM) using
an Immune System Inspired Algorithm (AIRS). Their results show that the AFDM
model improves detection accuracy by 25%, reduces costs by 85%, and
decreases system response time by 40% compared to traditional fraud detection
methods. Similarly, Bahnsen et al. (2016) developed a transaction aggregation
strategy and proposed a cost-based criterion for evaluating fraud detection
models. Their study used the von Mises distribution to analyze the periodic
behavior of transactions, demonstrating that feature engineering significantly
impacts fraud detection effectiveness.
Randhawa et al. (2018) explored various machine learning algorithms, including
Naïve Bayes, decision trees, neural networks, linear regression, and logistic
regression. They further introduced a hybrid method combining AdaBoost and
majority voting, showing that majority voting enhances fraud detection accuracy.
Meanwhile, Porwal and Mukund (2020) applied clustering techniques to detect
outliers in large datasets, assuming that legitimate user behavior remains stable
over time. Their findings suggest that fraudulent behavior can be identified by
analyzing changes in spatial data patterns.
To address data imbalance in fraud detection, Itoo et al. (2021) employed
oversampling techniques alongside logistic regression, Naïve Bayes, and K-
nearest neighbor algorithms. Their evaluation demonstrated that the logistic
regression-based model outperformed other fraud detection models in terms of
accuracy, sensitivity, and precision. Similarly, Altyeb et al. (2022) proposed a
Bayesian-based hyperparameter optimization algorithm to tune a LightGBM
model, which they tested on publicly available credit card fraud datasets. Their
results, evaluated using ROC-AUC, precision, and F1-score metrics, confirm the
efficiency of Bayesian optimization in improving fraud detection performance.
Additionally, Xiong et al. (2023) leveraged feature engineering techniques to
enhance fraud detection. Their model, trained on the IEEE-CIS fraud dataset,
outperformed traditional machine learning methods like Naïve Bayes and SVM,
proving the importance of advanced feature selection in fraud detection systems.

Online Banking Fraud Detection

Online banking fraud has emerged as a critical challenge in financial crime
management, resulting in substantial losses for banking institutions. Fraudulent
schemes such as phishing scams, malware infections, and ghost websites
continue to evolve, making fraud detection increasingly complex (Wei et al.,
2013). A major challenge in online banking fraud detection is that customers
rarely check their transaction history regularly, leading to delayed fraud
reporting and reducing the chances of loss recovery (Seeja & Masoumeh, 2014).
Effective fraud detection systems must exhibit high accuracy, low false positive
rates, and real-time detection capabilities, as existing methods often struggle
with efficiency and accuracy when applied to online banking fraud (Duman &
Ozcelik, 2011).
The work of Wei et al. (2013) highlights that online banking fraud exploits
interactions between resources in three domains:
1. Social world – fraudsters manipulate human interactions and social
engineering tactics.
2. Cyber world – they exploit weaknesses in web technologies and internet
banking infrastructure.
3. Physical world – they abuse trading tools and financial resources for
fraudulent activities.
Key challenges in online banking fraud detection include highly imbalanced
datasets, where fraud cases make up only a tiny fraction of transactions (Krenker
et al., 2009). Moreover, the dynamic nature of fraud behavior allows fraudsters
to mimic legitimate transactions, making it difficult to distinguish fraud from
genuine activity (Bhusari et al., 2011). To counteract this, Seeja & Masoumeh
(2014) proposed a frequent itemset mining approach to identify legal and
fraudulent transaction patterns, achieving improved classification accuracy.
Several studies have proposed advanced techniques for online fraud detection.
Duman & Ozcelik (2011) introduced a hybrid model combining genetic
algorithms and scatter search algorithms, improving fraud detection coverage by
200% in a large Turkish bank. Krenker et al. (2009) applied bidirectional neural
networks to cell phone transaction datasets, demonstrating superior
performance over rule-based systems in reducing false positives. Similarly,
Bhusari et al. (2011) employed Hidden Markov Models (HMMs), achieving high
fraud detection rates with low false positives.
A notable contribution is from Delio Panaro et al. (2015), who designed a two-
layer statistical classifier to handle massive, highly skewed datasets, analyzing
15 million online banking transactions from 2011 to 2013. Their approach proved
effective in detecting anomalies, achieving a high true positive rate while
maintaining a low false positive rate. Similarly, Mishra et al. (2014) compared
decision tree models and multilayer perceptron networks for credit card fraud
detection, demonstrating the trade-offs between accuracy and computational
efficiency.
For cost-effective fraud detection, Azeem Ush Shan et al. (2014) proposed the
Simulated Annealing Algorithm to train neural networks, offering real-time fraud
detection that is efficient for both individual users and financial organizations.
Additionally, Sahin et al. (2013) introduced a cost-effective decision tree
approach to minimize fraud detection costs while ensuring high accuracy.
Overall, existing studies emphasize fraud detection models that prioritize high
accuracy, cost and time efficiency, and low false positive rates. These remain
crucial factors in improving online banking fraud detection systems and
addressing the evolving landscape of financial fraud.

Artificial Neural Networks

Artificial Neural Networks (ANNs) are computational models inspired by biological
neural networks, composed of interconnected processing units called artificial
neurons. These neurons receive signals, process them, and transmit the
processed signals to other neurons. When used for fraud detection, ANNs
function as collections of neuron-like processing units with weighted connections
between them. Their ability to extract meaning from complex and imprecise data
has made them a state-of-the-art approach for fraud detection (Montague, 2012).
Montague (2012) introduced the Auto Encoder (AE) as a type of neural network
for fraud detection. An AE consists of an encoder and a decoder, following a
feed-forward ANN architecture where the output layer has the same number of
neurons as the input layer. The AE learns patterns from the majority of the
training data and identifies fraud cases based on anomalies in data distribution.
Transactions that exhibit high errors and deviations from the learned patterns are
flagged as fraudulent.
Bansal and Suman (2014) proposed the Self-Organizing Map (SOM) as another
type of neural network for fraud detection. The SOM operates in two phases:
training and mapping. During training, the system builds a map using input data,
and during mapping, it classifies new input vectors. The best matching node is
determined using the Euclidean Distance formula:
Dist=∑i=0n(Vi−Wi)2Dist = \sqrt{\sum_{i=0}^{n} (V_i - W_i)^2}Dist=i=0∑n(Vi
−Wi)2
where VVV represents the current input vector and WWW denotes the node’s
weight vector (Bansal & Suman, 2014).
Serrano et al. (2012) suggested using ANNs as a predictor for fraudulent
transactions. Their model employs Feed-Forward Networks, commonly used for
time-series predictions, particularly the Multilayer Perceptron (MLP), where all
neurons in a layer connect to the neurons in the subsequent layer. This approach
outputs a binary classification: '1' for fraudulent transactions and '0' for
legitimate ones.
The Naïve Bayesian classifier is a supervised Machine Learning technique that
predicts class membership probabilities, such as the likelihood of a transaction
being fraudulent. It is based on Bayes’ theorem, which provides a way to
compute posterior probability:

∣x)=p(x)p(Ck)p(x∣Ck)
p(Ck∣x)=p(Ck)p(x∣Ck)p(x)p(C_k | x) = \frac{p(C_k) p(x | C_k)}{p(x)}p(Ck

where p(Ck∣x)p(C_k | x)p(Ck∣x) is the posterior probability of the class (fraud or

non-fraud), p(Ck)p(C_k)p(Ck) is the prior probability, p(x∣Ck)p(x | C_k)p(x∣Ck) is
the likelihood, and p(x)p(x)p(x) is the prior probability of the predictor (Milgo &
Carolyne, 2016).
Milgo and Carolyne (2016) proposed a Bayesian approach for fraud detection,
particularly in ATM transactions. Their probability-based model helps banks
identify security issues related to ATM card usage and implement internal control
mechanisms to prevent fraud. However, they emphasize that the Naïve Bayesian
model is sensitive to missing data and requires careful preprocessing to enhance
accuracy.
Viaene et al. (2004) combined the Naïve Bayesian classifier with the AdaBoost
algorithm, developed by Freund and Shapire (1995), to classify valid and invalid
Personal Injury Protection (PIP) insurance claims. The AdaBoost technique
incrementally focuses on misclassified data instances, ensuring improved fraud
detection performance.
The k-Nearest Neighbour (k-NN) algorithm is a supervised Machine Learning
technique used for fraud detection. It categorizes transactions based on their
proximity in the feature space to known fraudulent or legitimate transactions.
Unlike other algorithms, k-NN does not perform explicit training; instead, it
classifies transactions at the time of prediction based on their nearest neighbors
(Sudha & Nirmal Raj, 2017).
Heta (2018) conducted a comparative study of k-NN, Random Forest, AdaBoost,
and Logistic Regression for fraud detection. His research demonstrated that k-NN
is highly effective in fraud classification due to its ability to detect outliers
efficiently. Additionally, k-NN requires less memory than other algorithms,
making it suitable for large datasets.
Malini and Pushpa (2016) proposed combining k-NN with the Hidden Markov
Model (HMM) to enhance fraud detection accuracy. While k-NN detects fraudulent
transactions based on distance calculations, HMM analyzes user behavior to
prevent recurring fraudulent activities. This hybrid model minimizes false alarms
and improves fraud detection rates.
Shen et al. (2007) demonstrated the efficiency of classification models in
addressing credit card fraud detection problems. The authors proposed three
classification models: decision trees, neural networks, and logistic regression.
Among these, neural networks and logistic regression outperformed decision
trees in detecting fraudulent transactions. Similarly, Islam et al. (2007)
introduced a probability theory framework for decision-making under uncertainty.
They reviewed Bayesian theory and implemented both the naïve Bayes classifier
and k-nearest neighbor classifier, applying them to credit card fraud detection
datasets.
Sahin and Duman (2011) conducted research on credit card fraud detection and
evaluated seven classification methods, including decision trees and support
vector machines (SVMs), to mitigate financial risks for banks. Their findings
suggested that artificial neural networks (ANNs) and logistic regression
classification models are particularly effective in improving fraud detection
performance. Moreover, their research indicated that ANNs outperformed logistic
regression classifiers when applied to biased training datasets, though all models
exhibited reduced efficiency in detecting fraudulent transactions when training
data distributions became increasingly skewed (Sahin & Duman, 2011).
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