International

International Academic Institute Academic

for Science and Technology Journal
of
International Academic Journal of Innovative Research
Vol. 2, No. 12, 2015, pp. 37-43. Innovative Research
ISSN 2454-390X www.iaiest.com

Smart Fraud Detection Systems for Credit Cards: Challenges

and Solutions
Farzaneh Papaa, Seyed Mehdi Jameib

a
Department of Computer Engineering, Faculty of Engineering Malard Branch, Islamic Azad University, Tehran, Iran
b
Department of Computer Engineering, Faculty of Engineering , Shahr-e- Qods Branch, Islamic Azad University, Tehran, Iran

Abstract
Nowadays using credit cards has become of the salient features of information technology penetration in
banking and financial affairs. The more is use of computer system in financial affairs, information
security and authentication of users become more important. Due to extending penetration to computer
networks and widespread counterfeiting credit and banking cards, producing automated systems that can
prevent from such kind of financial fraud is vital and important. Currently issues related to fraud detection
are not confined to only identification of Counterfeit credit cards, rather optimization issue is also
included. In the current paper, shortages in fraud detection systems are stated and architecture of
intelligent systems proposed based on innovative algorithms would be studied that have recently been
built in order to solve these deficiencies.

Keywords: genetic algorithms scatter search, fraud detection system, credit card, artificial neural
network.

Introduction:
Various systems have been proposed up to now for detection and identification of fraud in credit cards.
The main goal in these systems is separation of fake bank transactions from safe and legal transactions.
There are various methods for classification of these transactions (Tripathi and Pavaskar, 2012). In most
cases, algorithms and data mining classifiers are used. Decision Tree, Bayesian Network, Hidden Markov
Model (HMM), Support Vector Machine (SVM), and K Nearest Neighbor (KNN) can be mentioned as
examples of these classifiers. Also, fuzzy systems and regression are also used for improvement of these
systems (Tripathi and Pavaskar, 2012). The main point is increasing accuracy in these systems for
identifying fake transactions and better and correct classification of legal data from fake data.

37
 International Academic Journal of Innovative Research
Vol. 2, No. 12, pp. 37-43.

In this paper in the second section problems for fraud detection systems are reviewed. In the third section,
different methods proposed for fraud detection system in credit cards are stated and the proposed solution
by genetic algorithm is examined. In other method, a system based on two combined algorithms of
genetic algorithm (GA) and scatter search (SS) is investigated. Also, fraud detection method based on
neural network is also explained and then application of Hidden Markov Model (HMM) in fraud
detection system is studied. In third section, a method is discussed in which several classifiers available in
data mining is used for optimizing percentage of detection of fake transactions. Finally, conclusion is
provided and the proposed methods are compared.

Problems and Challenges for Fraud Detection in Credit Cards:

As mentioned in introduction, proper separation of fake transactions from legal ones is the major goal of
fraud detection systems. All existing systems are able to discover fake transactions and probability of
fraud occurrence in credit cards. Also, due to significance of the issue, and since financial and economic
matters are raised, the subsequent action upon identification of fake transaction is also important. Upon
observation and detection of fraud in a banking transaction, the user is warned and the bank take
necessary action in order to prevent from financial loss. Better and quick detection of frauds and due
reaction can provides more confidence to the bank users and increases bank value, and thus it will bring
about profits for the bank. Preservation of financial data of customers and feeling assurance that if there is
problem or fraud in their credit card, the bank would take measures as soon as possible is demanded by
any bank customer.
One of the challenges in using credit cards is increasing banking frauds through online purchase. When
the user wants to have purchase from an online shop, he registers. The website sends username and
password to the user’s email address and the user uses this username and password next time when
entering the website (Shabbir and Kannadasan, 2013). During purchase only bank card characteristics are
checked and if they are correct, the user does purchase. Personal characteristics and confidential
information of the user as well as his card characteristics are not received at the time of registration, and
only email address is examined. That is, it is clear if the person who does online shopping is the same as
original credit card owner or not. Thus, any user (including hackers) can make account in internet
websites with having and generating fake email, and site administrator realizes this after occurrence of
fraud and user complaint (Shabbir and Kannadasan, 2013).
Generation of such systems which are able to identify such online frauds quciky is critical. Identification
and detection of fake transactions in low and limited quantities does not provide special problems for the
banks. When fraud occurs at macro level the problem gets critical and sensitive, and high losses are
incurred by the customer and bank. Also, since there isn’t total accuracy in fraud detection systems and in
separation of fake and legal transactions, and often it accompanies with some errors, legal transactions
would be found that are wrongly predicted as fake and vice versa. The goal is reducing such wrong
predictions and increasing accuracy in the system. If a legal transaction is wrongly predicted as fake by
the system, there would not high loss. The main problem happens when a fake transaction, which contains
high amounts in the worst conditions, is predicted as legal and safe transaction by the system. It is true
that systems attempt to reduce wrong predictions, but the main issue involved by fraud detection systems
in credit cards is detection of fake transactions, which have high risk (with high amounts), and in case of
wrong identification of these transactions as legal ones, the bank and customer would incur high loss.

38
 International Academic Journal of Innovative Research
Vol. 2, No. 12, pp. 37-43.

Thus, here the problem is not separation of transactions from each other; rather problem is selection of
fake transactions with high risk. That is, an optimization problem. It means that fraud detection systems
should optimize their function by identification of high risk fake transaction(s). To this end, instead of
using common data mining algorithms, these systems use optimization Heuristic Algorithms.

Various Methods of Fraud Detection in Credit Cards:

In this section, different methods of fraud detection in banking credit cards are introduced and their
advantages and disadvantages are reviewed.

Genetic Algorithm for Fraud Detection in Banking Card:

Genetic algorithm is an innovative method for solving complicated computational issues and it is used to
help optimization, simulation, model design, and prediction in basic sciences, medicine, engineering, etc.
(Vats, dubey and Pandey, 2013). Genetic algorithm aims at finding optimal solution out of existing
solutions. Creative idea in this work is time and cost saving. Genetic algorithm is also highly used in data
mining. This powerful algorithm can also be used in modeling for feature selection and classification and
ranking data. Data related to each banking transaction is considered as algorithm inputs. Each feature of
transaction can be selected based on genetic algorithm and optimal transactions are found. In this case,
optimal solution is high risk fake transactions which should be separated from other banking transactions.
Combination operator can be performed on different parameters and features of each transaction
(algorithm input) so that better features are generated, and finally higher accuracy in selection and
separation of fake transactions from legal ones can be obtained.
Overall initial operation can be divided into four steps (Patel and Singh, 2013):

Step 1: All input transactions are grouped and some attributes are assigned to each transaction. A dataset
is generated using these transactions and data are standardized and confidential information of card owner
is also kept in this set.

Step 2: Critical values are specified and frequency credit card usage, place of credit card usage, bad check
amounts, as well as average daily intake of card are determined.

Step 3: These critical values are again calculated after several implementation of genetic algorithm to
reach specific new generation. Critical (risky) detected fraud, controllable detected fraud, and normal
detected fraud can be obtained using genetic algorithm.

Step 4: Using this algorithm, fake transactions are found. Correctness of fraud detection is investigated
based in this method, and detection method, which is obtained based on generated critical points, is
included in fraud detection system. Using genetic algorithm, fraud in credit cards can be detected such
quicker.

Combination of Genetic Algorithm with Other Algorithms:

39
 International Academic Journal of Innovative Research
Vol. 2, No. 12, pp. 37-43.

In this section, in order to improve function of genetic algorithm, it is used as combined with scatter
search algorithm so that deficiencies are compensated. As mentioned in introduction, common data
mining algorithms are not able to estimate data misclassification costs. Then only can reduce errors in
prediction, but they are not able to identify data influential in occurrence of errors (Duman and Ozcelik,
2011).they are not able to realize which fake transactions can bring highest risk leading to
misclassification of transactions.
Most customers follow fixed and specific behavior and rarely change it. Using combination of both
algorithms, dynamic state in behavior of counterfeiters as well as usual behavior of credit card holders
can be considered. It can be investigated that unusual behavior in a banking transaction may have
probability of fraud and counterfeit. Scatter search algorithm is similar to genetic algorithm with this
acceptation that prior to generating initial population, firstly improving operators like mutation are
applied on some inputs, and then a combination of improved and intact members is constituted so that
initial population (reference set) is built. With this way of initial population generation, a population with
high quality and diversity is obtained. Then, the best ones are selected and combined with data in highest
diversity so that new population is generated.
In the study by Duman and Ozcelik (2011) statistics related to transactions, location of transaction,
number of transactions, amounts of transaction as well as customer behavior variables were considered as
parameters (input). For behavioral variables of each transaction a threshold was considered. If the
threshold was exceeded, it was considered as suspicious transaction, and fraud occurrence probability was
investigated in it. In this case, either transaction is ignored or it shown as warn on the bank’s control panel
and the credit card is blocked or a message is sent to the card holder. Total number of parameters is 43.
The aim is finding the best value for these 43 parameters. Initial population number is considered up to
50, 47 of which are obtained from combination of 43 parameters, and three other members include
following cases: Maximum number of alerts on transaction (MAX), minimum number of alerts (MIN)
and a warning that has been used recently (PRD). Basis for finding high risk fake transaction is done by
these three members. MAX and MIN members determine upper and lower limits for diversity of initial
population.
In this method, for combination operator, weight average of parental parameters is used and children are
generated. This type of combination is common in scatter search algorithm. For mutation operation, one
of children is randomly selected and its value in the internal related to the variable is changes. Previous
frauds can be considered as a criterion for changing proportion value in each transaction. Also, in order to
stabilize number of members in the subsequent generation, three best members are selected from each
generation. Three members of MAX, Min, and PR, which are the most effective members in the
population, are automatically transferred to the next generation. 46 other members are selected using
Roulette Wheel Selection. The condition for stopping this combined algorithm is that no optimal solution
is obtained for at least 10 consecutive iterations (10 generations). Finally, accuracy of finding optimal
solution reached to 200% and this optimal solution caused 189% loss compensation, but incorrect
prediction numbers were also increased by 36%. Loss compensation had higher priority here over correct
prediction.

40
 International Academic Journal of Innovative Research
Vol. 2, No. 12, pp. 37-43.

Using Neural Network:

Fraud detection system acts based on Artificial Neural Network (ANN) like human brain system.
Artificial Neural Network technology has caused that computer can think. Human brain learns
from previous experiences and uses it for knowledge generation and awareness for solving daily issues.
The same technique is used for fraud detection in credit cards. When the person uses his credit card, he
manifests specific pattern and behavior in using the card which distinguishes him from other users
(Patidar and Sharma, 2011). Using data for one or two recent years of cardholder, neural network learns
user’s usage pattern for his card. These data include such cases as number of purchases with high value,
frequency of purchases, where the user purchases with a large sum as well as personal information such
as age, income and occupation of the user.
In addition to these information, neural network generates a pattern considering different frauds in a
specific bank, and using these data it can predict if the current transaction is fake or safe. When unknown
person uses the card, neural network contrasts behavior and pattern of the person with its stored and learnt
pattern from original card holder. If the pattern of using the card is matched to the pattern of original hard
holder, the transaction is safe, otherwise it is fake. The information which is given to the neural network
for registering pattern of each credit card holder are considered as nodes in input later of network. Hidden
layer acts for processing and learning network based on inputs (pattern match) and output layer
recognizes (fake or safe) transaction (Patidar and Sharma, 2011).

Figure 1. Neural network generated for fraud detection in credit card

Hidden Markov Model:

Hidden Markov Model is a hybrid and embedded stochastic process for modeling. Complexity of this
stochastic process is higher than common Markov model. If bank transaction is not accepted by learner
Hidden Markov Model with high probability, it is considered as unsafe and fake transaction. Baum Welch
algorithm is used for model learning and K-Means algorithm is used for data classification. The model
classifies transactions in terms of high, average and low level. Initial probability for each transaction is

41
 International Academic Journal of Innovative Research
Vol. 2, No. 12, pp. 37-43.

generated and fraud detection system determines that which transaction is safe and which one is fake
(Tripathi and Pavaskar, 2012). Since Hidden Markov Model stores performed operation history, the work
is easy for system user. However, error probability in detection is high.

System Improvement Using Meta Classifier Algorithms:

For improving fraud detection system, multiple classifiers can be used which is known as Meta
classification strategy in Pun and Lawryshyn (2012). In the study by Pun and Lawryshyn (2012), firstly
legal and fake transactions are classified using artificial neural network. Also, a vale from 1 to 999 is
given to each transaction as output. 1 denotes legal transaction and 999 denotes transaction with highest
risk of fraud probability. According to statistics, transactions with scores between 990 and 999 are four
times more for fraud and counterfeit detection probability. Also, other statistics state only 20 percent of
transactions with score above 900 is fake and mostly are legal.System of prioritizing transactions is based
on neural network or based on these scores or based on amounts of transactions.
In the current research, in order to improve identification of fake transactions, multiple classification
method including decision tree, Naïve Bayesian and K Nearest Neighbor is used. It aims at prioritizing
fake transactions so that high risk transactions can be found. The reason for using these three classifiers
is that combination of these three models provides highest diversity and scattering compared to other
combinations of algorithms.
Firstly, results obtained from classification with artificial neural network are given to meta-classifier as
training set. This set includes 8-month data. Half of data are legal transactions and the other halve are
fake ones. This meta-classifier classifies transactions based on the probability. That is, it assigns a value
to transactions as probability using some calculations. If this value is larger or equal to 0.5, it is regarded
as fake transactions; otherwise it is regarded as legal one. Size of training, validation and test set for meta-
classifier model is determined considering Receiver Operative Characteristic (ROC).
As mentioned, information of 8 months of banking transactions for training set, information of 2 months
of banking transactions for validation set, and information of 1 month of banking transactions for test set
is included. This type of data classification have had highest Receiver Operative Characteristic (ROC).
With applying this multiple classifier after artificial neural network model and comparing its accuracy
with initial model, ability of system in fraud detection for credit cards is increased by 28 percent.

Conclusion:
In the current paper, different methods of fraud detection in credit cards were investigated. Firstly,
significance of the subject was stated and existing deficiencies in traditional systems were mentioned.
Fake transactions have also varying degrees of risks and ways should be found for finding transactions
with highest risk in quicker and more accurate manner. For identification of these transactions, common
data mining methods alone do not suffice. Innovative algorithms should be used for finding the best
answer. Firstly using genetic algorithm in these systems was mentioned and its concepts were discussed.
Then for increasing data scattering in order to extend search space, a research was mentioned as example
in which combination of genetic algorithm and other optimization algorithm like scatter search was used.
In this method, behavior of counterfeiters and customers of credit cards is used as input to the algorithm.
It was shown that using this method, losses are considerably reduced. Also, fraud detection system of
credit cards was discussed using neural network which is a learning algorithm. Application of Hidden

42
 International Academic Journal of Innovative Research
Vol. 2, No. 12, pp. 37-43.

Markov Model in fraud detection was also summarized and its advantage over common Markov Mode
was discussed. In the other method, a meta-classifier was used and deficiencies in other methods were
covered. Though using neural network for identification of fake transaction from legal ones is common,
using multiple classifier in this method can increase system performance by 28 percent. Hence, it can be
concluded that in cases where is there is time for system construction and promotion, using several
predictor medals as consecutive can increase accuracy.

Also, since nowadays time and costs are the highest priorities in every work, the best possible answer
should be searched instead of finding several medium answers so that time and costs is saved. Thus,
instead of using simple algorithm, innovative optimization algorithms which give the best solution should
be worked. Combined use of innovative algorithms like genetic algorithm, Imperialist Competitive
Algorithm (ICA), Particle Swarm Optimization (PSO), Ant Colony, etc. along with common data mining
algorithms can be useful and effective in optimal classification of data and finding the best solution.

References:
Duman, E., & Ozcelik, M. H. (2011). “Detecting Credit Card Fraud By Genetic Algorithm And Scatter
Search”. Expert Systems with Applications, 38(10), 13057-13063.
Patel, R. D., & Singh, D. K.(2013). “Credit Card Fraud Detection & Prevention of Fraud Using Genetic
Algorithm”. International Journal of Soft Computing and Engineering (IJSCE) ISSN, 2231-
2307.
Patidar, R., & Sharma, L. (2011). “Credit Card Fraud Detection Using Neural Network”. International
Journal of Soft Computing and Engineering (IJSCE), 1(32-38).
Pun, J., & Lawryshyn, Y. (2012). “Improving Credit Card Fraud Detection Using A Meta-classification
Strategy”. International Journal of Computer Applications, 56(10), 41-46.
Shabbir, S. A., & Kannadasan, R.(2013). “An Effective Fraud Detection System Using Mining”.
International Journal of Scientific and Research Publications, 415.
Tripathi, K. K., & Pavaskar, M. A. (2012). “Survey on Credit Card Fraud Detection Methods”.
International Journal of Emerging Technology and Advanced Engineering, 2(11).
Vats, S., Dubey, S. K., & Pandey, N. K. (2013). “Genetic Algorithms For Credit Card Fraud Detection”.
International Conference on Education and Educational Technologies

43