Thesis Research Proposal

Advanced Techniques for Fraud Detection in

Transactional Operations Using Machine Learning
and Data Analytics.

Master student:

Mohammed Amine Goumri

Master specialization:

Business Analytics 2

Supervisor:

Pr.Abla Chaouni Benabdellah

Date of submission:

30/12/2024
Abstract:
Detecting fraudulent activities in transactional operations has become increasingly
challenging due to the rapid evolution of fraud techniques and the vast amounts of data
produced daily. This research focuses on employing advanced machine learning approaches
to combat fraud in real-time transactional environments. By leveraging banking and credit
card data, the study will implement and evaluate algorithms such as XGBoost, Neural
Networks (NN), Support Vector Machines (SVM), and Random Forest to improve fraud
detection accuracy.

The research aims to address critical challenges, including the complexities of handling large-
scale real-time data, data imbalance issues, and ensuring computational efficiency and
prediction precision. By tackling these obstacles, the study seeks to enhance the effectiveness
of fraud detection systems.

This work holds significant value in the fight against the continually evolving methods of
fraudsters. Introducing these advanced technologies into banking and other susceptible
industries will contribute to reinforcing financial security and ensuring safer transaction
processes for individuals and businesses alike.
Contents

1) Introduction.
2) Literature review.
3) Research Methodology.
4) Expected results/Contributions.
5) Conclusion.
6) References.
Introduction
Fraud detection in transactional operations is a critical issue in our increasingly digital and
interconnected world. As financial systems evolve, fraudsters continually develop
sophisticated methods to exploit vulnerabilities, making fraud prevention a pressing concern
for businesses and individuals alike. The importance of this subject lies not only in
safeguarding financial assets but also in maintaining trust in digital payment systems, which
form the backbone of modern economies. With the exponential growth of data generated
daily and the adoption of real-time financial transactions, the field of fraud detection has
become dynamic and fast-paced. This evolving nature demands equally agile and adaptive
solutions, leveraging advanced technologies such as machine learning and artificial
intelligence. Staying ahead in this battle is not just a technological challenge but a societal
imperative, as it ensures financial security, fosters innovation, and protects consumers from
potential harm. Our approach must mirror the agility and creativity of fraudsters, constantly
advancing and refining techniques to create resilient and future-proof fraud detection
systems.

The rapid evolution of digital transactions has brought significant convenience to businesses
and individuals, but it has also created a fertile ground for fraudulent activities. Fraudsters are
becoming increasingly sophisticated, leveraging advanced tools and techniques to exploit
vulnerabilities in transactional systems.

This poses a critical challenge to the security and integrity of financial systems, especially as
the volume of real-time data generated by these transactions grows exponentially.

Despite advances in fraud detection, many systems still struggle to keep pace with the
complexity and agility of modern fraud schemes. Challenges such as handling large-scale,
real-time data, addressing data imbalances, and achieving computational efficiency often
hinder the effectiveness of fraud prevention measures. Moreover, traditional methods
frequently fail to adapt to new fraud patterns, leaving systems vulnerable and reactive rather
than proactive.

This research aims to address the pressing problem of improving fraud detection in
transactional operations by developing robust, adaptive, and scalable machine learning
solutions. The study will focus on leveraging advanced algorithms to detect fraudulent
activities in real-time, overcoming existing limitations, and enhancing the overall reliability
of fraud detection systems. By tackling this issue, the research seeks to contribute to the
ongoing effort to safeguard financial transactions, protect consumers, and strengthen trust in
digital payment ecosystems.

All of that let us ask the following questions:

 How can advanced machine learning techniques be leveraged to enhance fraud

detection in real-time transactional operations?

 What are the key challenges in detecting fraud within large-scale, real-time data
streams, and how can these be effectively addressed?
 How do machine-learning algorithms such as XGBoost, Neural Networks, Support
Vector Machines, and Random Forest compare in terms of accuracy, scalability, and
efficiency for fraud detection?
 What strategies can be implemented to overcome data-related issues, such as
imbalanced datasets, to improve fraud detection performance?
 How can the insights gained from this research contribute to the development of
adaptive and future-proof fraud detection systems in the banking sector and beyond?
Literature review:

The problem becomes evident in the case of financial fraud, evidenced by the 2022 figures of
the PricewaterhouseCoopers survey report revealing that 56% of companies globally have
fallen victim to some form of fraud. In Latin America, 32% of companies have experienced
fraud (PricewaterhouseCoopers, 2022). These alarming statistics align with the findings from
Klynveld Peat Marwick Goerdeler (KPMG), indicating that 83% of the surveyed executives
reported being targeted by cyberattacks in the past 12 months. Furthermore, 71% had
encountered some type of internal or external fraud (KPMG, 2022). These survey results
reveal the higher risks of financial fraud faced by companies in Latin America, the United
States, and Canada. In this context, traditional approaches, and techniques, as well as manual
methods, have lost relevance and effectiveness because they cannot effectively address the
complexity and scale of the information involved in detecting financial fraud.(Hernandez
Aros et al. 2024)

Covering a wide range of financial fraud types from credit card fraud to account hijacking to
money laundering, these cases illustrate how machine-learning models can play a role in
monitoring transaction activities in real time, identifying unusual behaviours, and adapting to
new fraudulent tactics.(Pan, n.d.) Traditional methods have relied heavily on rule-based
systems, which, while effective to some extent, have notable limitations that necessitate more
adaptive and dynamic solutions. Rule-based systems are the cornerstone of traditional fraud
detection methods. These systems operate on predefined rules and criteria established by
experts based on historical data and known fraud patterns. For example, a rule might flag
transactions exceeding a certain threshold within a short time frame or originating from
unusual geographic locations. These rules are simple to implement and understand, providing
a straightforward mechanism for identifying potentially fraudulent activities.(Bello et al. 2023).

This led us to search for another methods and techniques that has less limitation and armed
with agility, in our case, there is many machine-learning models, that can fill the empty cube
in the building but it is crucial to know which one to choose. Artificial neural networks have
come to the front as an at least partially successful method for fraud detection. The success of
neural networks in this field is, however, limited by their underlying design - a feedforward
neural network is simply a static mapping of input vectors to output vectors, and as such is
incapable of adapting to changing shopping profiles of legitimate cardholders. (Wiese and
Omlin, n.d.)

(‘FRAUD DETECTION IN FINANCIAL TRANSACTIONS | Advances and Applications in

Statistics’, n.d.) Alsulami , A., & Alabdan, R. (2024) Merged data pre-processing, feature
engineering, and model evaluation. The paper uses machine learning models such as logistic
regression, Cat Boost, decision trees (DTs), and random forests to compare performances and
pick the best one for the study case. Accuracy, F-scores, precision, recall, and support values
determine model performance. The results in this paper indicate that DT and Cat Boost
provide the highest level of accuracy, at 99.9% and 99%, respectively.

These discoveries establish the potential of machine learning in significantly improving fraud
detection.

(Seyedeh Khasemi et al.)(‘(PDF) Fraud Detection in Online Transactions Using Machine

Learning’, n.d.)Address the challenge of imbalanced data, a common issue in fraud detection.
They propose a weight adjustment pre-processing technique to balance data and enhance
detection performance. By using advanced algorithms like CatBoost and XGBoost and
incorporating a voting mechanism, they achieved improved results in fraud detection
compared to traditional methods. They also acknowledge the limitations imposed by
hardware constraints and suggest that more robust computing resources could yield results
that are even more favourable. This highlights the need for continuous hardware
advancements to support more complex fraud detection models.

This subject is sensitive that is why I have chosen the most recent articles with the most
significant results and common research goals.
Value of fraud loss in the United States from 1st quarter 2020 to 3rd
quarter 2024, by payment method:

(‘Fraud Loss by Payment Method U.S., by Quarter’, n.d.)

The graph clearly illustrates a concerning trend of increasing fraud rates across various fields
in the coming years, highlighting the growing sophistication of fraudulent activities. As
technology advances and digital transactions become more widespread, fraudsters are
developing increasingly complex tactics to exploit vulnerabilities in financial systems, e-
commerce platforms, and other sectors. This surge in fraudulent behaviour makes fraud
detection and prevention more critical than ever, as it not only threatens the financial stability
of businesses but also erodes consumer trust in digital systems. The rise in fraud across
diverse fields emphasizes the urgency of developing more effective and adaptive detection
systems, reinforcing the relevance and importance of this research in safeguarding financial
transactions and securing sensitive data. This graph underscores the need for continuous
innovation in fraud detection to stay ahead of emerging threats and protect both businesses
and consumers from significant losses.
There is a clear gap in the existing fraud detection systems, particularly in addressing the
evolving and increasingly sophisticated nature of financial fraud. Traditional methods, such
as rule-based systems, are limited in their ability to adapt to the dynamic patterns of fraud,
especially as fraudsters continue to develop techniques that are more advanced. While these
traditional systems have proven effective in some contexts, they fail to scale effectively with
the volume and complexity of modern data and fraud activities, especially in real-time
environments.

Moreover, while machine learning (ML) models, including decision trees, CatBoost, and
neural networks, have demonstrated potential in fraud detection, they still face limitations
such as adapting to shifting patterns in transactional data and handling imbalanced datasets.
Although studies have highlighted improvements using machine-learning techniques such as
XGBoost, CatBoost, and advanced neural network models, these models still need more
robust optimization, particularly in real-time fraud detection, and a more comprehensive
approach to data pre-processing and feature engineering. Furthermore, the performance of
these models is often contingent upon the availability of robust hardware resources, which
remains a challenge in many organizations.

There is also a lack of research into combining various machine-learning models in a hybrid
system that can dynamically adjust to both emerging fraud tactics and changing data
conditions. Despite some studies exploring hybrid models, the optimal approach for
seamlessly integrating these different models to achieve higher accuracy, efficiency, and real-
time performance has not been fully explored.

In summary, the research gap lies in developing more adaptive and scalable fraud detection
systems that leverage machine learning models to address the complexity, volume, and
evolving nature of fraud. Additionally, further research is needed on hybrid models, data pre-
processing techniques for imbalanced datasets, and optimization of hardware resources to
support the growing need for real-time fraud detection.
Methodology

1. Research Design

This research will take an applied, quantitative approach to test multiple machine learning
models for fraud detection in transactional operations. The focus will be on evaluating the
performance of various models using a credit card transaction dataset. The primary aim is to
compare the effectiveness of these models in identifying fraudulent activities and adapting to
the dynamic nature of fraud detection.

2. Data Collection

The dataset used for this study will be sourced from Kaggle, a platform that provides a wide
range of publicly available datasets. The specific dataset will focus on credit card
transactions, which contains both legitimate and fraudulent transaction data. If access to
proprietary data is granted by the banking organization, the dataset may be replaced with the
organization's internal transaction data. The dataset will include various features, such as
transaction amount, location, timestamp, and other transaction details, which will be used for
training the fraud detection models.

3. Data Preprocessing

Before applying machine learning algorithms, the data will undergo standard preprocessing
steps:

 Data Cleaning: Missing values will be addressed by either imputing with

mean/median values or removing rows with missing data. Outliers and noise will be
detected and managed using appropriate techniques.
 Feature Engineering: New features may be created based on the existing ones to
improve model performance (e.g., aggregating transaction amounts over time
windows or encoding categorical data).
 Normalization/Standardization: Since machine learning models, especially neural
networks, can be sensitive to the scale of the data, all numerical features will be
normalized or standardized to ensure consistency and improve the model's
performance.
  Handling Imbalanced Data: Fraudulent transactions typically make up a small
proportion of the data. To address this, techniques such as oversampling (e.g.,
SMOTE) or under sampling will be applied to balance the dataset and improve the
detection of fraudulent activities.

4. Model Selection

Several machine-learning algorithms will be implemented and compared to determine the

best approach for fraud detection in this context:

 XGBoost: A powerful gradient-boosted decision tree model that has been successful
in many classification tasks, particularly when dealing with imbalanced datasets.
 Random Forest: An ensemble method based on decision trees, effective for
classification and robust to overfitting.
 Neural Networks (NN): Deep learning models will be tested to capture non-linear
relationships and complex patterns in the data.
 Support Vector Machines (SVM): This model will be tested due to its strength in
high-dimensional spaces, which is typical of fraud detection problems.

These models will be chosen based on their proven ability to handle large, complex datasets
and their potential to adapt to evolving fraud patterns.

5. Model Evaluation

The performance of the models will be evaluated using the following metrics:

 Accuracy: To measure the overall correctness of the models.

 Precision and Recall: These metrics are especially important for fraud detection,
where false positives and false negatives need to be carefully managed.
 F1-Score: A balanced metric that considers both precision and recall.
 Confusion Matrix: To visualize the performance of each model and understand the
classification of fraudulent vs. legitimate transactions.
 Cross-Validation: K-fold cross-validation will be applied to assess the models'
robustness and ensure that they generalize well to unseen data.

6. Software and Tools

The research will utilize the Python programming language, with the following libraries:

 Scikit-learn: For implementing machine learning algorithms and evaluating models.

 XGBoost: For the gradient-boosted tree model.
 TensorFlow/Keras: For building and testing neural network models.
 Pandas and NumPy: For data manipulation and preprocessing.
 Matplotlib and Seaborn: For visualizing data and model performance.

7. Limitations and Challenges

Potential challenges that may arise during the research include:

 Data Quality: The dataset may contain inaccuracies or missing values, which could
affect the model's performance.
 Imbalanced Dataset: Fraud detection datasets typically have an imbalanced
distribution of fraudulent and legitimate transactions, which might lead to model bias.
Techniques like oversampling and under sampling will be applied to mitigate this
issue.
 Computational Resources: The complexity of the models, especially neural
networks, may require significant computational resources, particularly when training
on large datasets.
 Dynamic Fraud Tactics: Fraud tactics continuously evolve, making it a challenge to
ensure that the models remain effective over time. Continuous evaluation and updates
will be necessary.

8. Ethical Considerations

Data privacy will be a top priority throughout the research. If proprietary banking data is
used, measures will be taken to anonymize and secure sensitive information. Additionally,
fairness and transparency will be key considerations to ensure that the fraud detection models
do not unintentionally discriminate against certain groups or individuals.
Program of work

Month 1: Research Preparation and Data Preprocessing

1. Literature Review
o Conduct a comprehensive review of existing studies on fraud detection and
machine learning techniques.
o Identify research gaps and finalize the research problem.
2. Dataset Selection
o Acquire initial data from Kaggle or other public sources.
o Coordinate with the partner organization (if applicable) to gain access to
proprietary data.
3. Tool and Framework Setup
o Finalize the tools and libraries (e.g., Python, TensorFlow, Scikit-learn).
4. Data Cleaning and Preprocessing
o Handle missing values, outliers, and noise.
o Normalize and scale numerical features.
o Address data imbalance using techniques like SMOTE or weight adjustments.

Month 2: Data Exploration and Model Development

1. Exploratory Data Analysis (EDA)

o Visualize data patterns, correlations, and trends to understand the dataset.
2. Feature Engineering
o Extract meaningful features (e.g., transaction frequency, amounts, time
intervals).
3. Algorithm Selection and Initial Development
o Implement multiple models, including Random Forest, XGBoost, Support
Vector Machines, and Neural Networks.
4. Initial Training
o Train models on the preprocessed dataset using cross-validation techniques.

Month 3: Model Optimization and Real-Time Testing

1. Hyper parameter Tuning

o Optimize model parameters using grid search or random search techniques.
2. Performance Evaluation
o Evaluate models using accuracy, precision, recall, F1-score, and AUC-ROC.
o Identify the best-performing model based on evaluation metrics.
3. Real-Time Simulation
o Test models in a simulated real-time environment.
o Measure latency, scalability, and computational efficiency.

Month 4: Finalization and Reporting

1. Framework Development
 o Develop a scalable fraud detection framework based on the best-performing
model.
2. Result Analysis
o Summarize findings, key challenges, and insights gained during the research.
3. Report Writing
o Prepare a detailed research report, including methodology, results, and
contributions.
4. Presentation and Dissemination
o Present findings to stakeholders and prepare for submission to journals or
conferences.
Bibliography

Bello, Oluwabusayo Adijat, Adebola Folorunso, Oluomachi Eunice Ejiofor, Folake Zainab
Budale, Kayode Adebayo, and Olayemi Alex Babatunde. 2023. ‘Machine Learning
Approaches for Enhancing Fraud Prevention in Financial Transactions’. International
Journal of Management Technology 10 (1): 85–108.
‘FRAUD DETECTION IN FINANCIAL TRANSACTIONS | Advances and Applications in
Statistics’. n.d. Accessed 29 December 2024.
https://www.pphmjopenaccess.com/index.php/aas/article/view/1806.
‘Fraud Loss by Payment Method U.S., by Quarter’. n.d. Statista. Accessed 30 December
2024. https://www.statista.com/statistics/958997/fraud-loss-usa-by-payment-method/.
Hernandez Aros, Ludivia, Luisa Ximena Bustamante Molano, Fernando Gutierrez-Portela,
John Johver Moreno Hernandez, and Mario Samuel Rodríguez Barrero. 2024.
‘Financial Fraud Detection through the Application of Machine Learning Techniques:
A Literature Review’. Humanities and Social Sciences Communications 11 (1): 1–22.
https://doi.org/10.1057/s41599-024-03606-0.
Pan, Eryu. n.d. ‘Machine Learning in Financial Transaction Fraud Detection and Prevention |
Transactions on Economics, Business and Management Research’. Accessed 30
December 2024. https://wepub.org/index.php/TEBMR/article/view/1045.
‘(PDF) Fraud Detection in Online Transactions Using Machine Learning’. n.d. Accessed 30
December 2024.
https://www.researchgate.net/publication/376518057_Fraud_Detection_in_Online_Tr
ansactions_Using_Machine_Learning.
Wiese, Bénard, and Christian Omlin. n.d. ‘Credit Card Transactions, Fraud Detection, and
Machine Learning: Modelling Time with LSTM Recurrent Neural Networks’. In .
Accessed 30 December 2024. https://doi.org/10.1007/978-3-642-04003-0_10.