Scalable and Verifiable Federated Learning for Cross-Institution Financial Fraud Detection

Abstract

Financial fraud increasingly exploits institutional boundaries: laundering networks distribute transactions across multiple banks because no single institution can observe the full pattern. Federated Learning (FL) enables collaborative detection without raw data sharing, yet practical deployment in banking environments remains constrained by three pressures. First, homomorphic encryption schemes impose high computational costs that limit real-time aggregation at scale. Second, mask-based protocols such as Google's SecAgg require O(N^2) pairwise key exchanges, which become inefficient as participant count grows. Third, existing protocols provide limited verification that submitted gradient updates are well-formed, leaving aggregation vulnerable to consistency attacks. This paper presents Dynamic Sharded Federated Learning (DSFL), a secure aggregation framework for cross-institution fraud detection. DSFL introduces Dynamic Stochastic Sharding, which partitions participants into small cryptographically ephemeral clusters of fixed size m, reducing communication complexity to O(N*m). Within each cluster, participants submit Linear Integrity Tags, additive-homomorphic commitments that allow the server to verify update consistency without decryption. The mechanism detects inconsistent updates rather than malicious gradients. An Active Neighborhood Recovery protocol handles mid-round dropouts by reconstructing orphaned masks. Experiments on the ULB Credit Card Fraud Detection dataset (284,807 transactions across 10 simulated banking nodes) show that DSFL achieves approximately 34x lower aggregation latency than Paillier-based secure aggregation at N=1000, based on analytical extrapolation from empirical baselines, while maintaining 99% recovery fidelity under a 20% dropout regime. Global fraud recall reached 91.2% (+/-0.8%), above the 68% average of locally trained models.