The information services company Experian has conducted tests on reducing housing benefit fraud in nine areas which it said saved the taxpayer up to £17m. It looked for "unusual patterns of spending" in households receiving the benefit which could suggest the claimants had other sources of income not being declared to town halls which administer payments. The firm also attempted to identify claimants who have an undeclared partner who is at work by examining electoral registers and highlighting shared bank accounts.

The initiative on housing benefit, set up by the previous government, is to be rolled out across the country by the end of the year by the Department for Work and Pensions (DWP) headed by Iain Duncan Smith.

Experian said it did not use the technique to identify fraudsters, but to flag up to local councils those addresses where it believed there was "potential for fraud" and merited further investigation. With the housing benefit bill running at nearly £20bn, the Chancellor George Osborne last week announced moves to shave £1.7bn a year off the costs by 2014-15.

Experian is also negotiating with the DWP over ways of clamping down on fraudulent claims of incapacity benefit, claiming to be able to achieve savings of £300m. Again using information about consumer spending, it would attempt to pinpoint households who appeared to be living beyond the means of a benefit claimant, such as building up large lines of credit.

The company said that the change of government in May had led to a "sharp gear change" in the DWP's focus on combating fraud. Andrew Davis, head of fraud for Experian Public Sector, said: "We are picking up increased activity in all areas of government. They are really, really trying to find savings, using whatever tools and techniques are out there."

The firm said it operated within strict data protection rules stipulating private information could only be shared with public bodies to detect fraud. However, the use of credit agencies by the public sector was condemned last night by the pressure group Big Brother Watch.

Alex Deane, its director, said: "Nobody approves of benefit cheats. But mining private data on a routine basis on the off-chance of catching people out is a disproportionate invasion of privacy. Credit agencies should think carefully about effectively becoming enforcers for the state, compromising private information about people."

Phil Booth, national co-ordinator of NOID, which campaigns against the "database state", denounced the use of credit agencies as a "recipe for snooping". "This is a very significant blanket intrusion into private financial information," he added.

The DWP confirmed it was examining ways of increasing the use of credit agencies. "The department recognises the valuable role credit reference agencies play in countering fraud and is exploring how private sector prevention and detection practices could be used to further tackle fraud in the benefit system and save the taxpayer money," said a spokeswoman.

However, its use could cause alarm among Liberal Democrat MPs anxious over the political direction of the coalition administration. Mr Clegg has promised that the new government will "stand up against illegitimate advances of the state". Last night Liberal Democrat MPs said they wanted to see how the use of credit agencies turned out in practice. One senior party figure said: "I would be very concerned if the credit agencies are acting aggressively. We need to be sure that they are behaving in accordance with the relevant codes of conduct."

Case study: Held at gunpoint over a case of mistaken identity

John Irving, 55, a management consultant from Norwich, he was confused for a criminal wanted for extradition by the US.

"I was unfortunate enough to share the same name as a chap wanted for extradition by the Americans for his involvement with the oil-for-food programme in Iraq – he has subsequently admitted it in a plea bargain. The whole thing was perpetrated by a couple of financial institutions who created a false record on the Experian database – a bank and a credit card company.

"The problem was that this bloke and I shared a name and we both had accounts there. Some lowly clerk had created a financial association between the two of us – I was completely innocent of that.

"When I tried to go to America on a family holiday in August 2004 I was detained. We were going through immigration and border control in a very quiet part of Canada and it was all very pleasant until the border control system went into meltdown.

"I hadn't a clue what it was all about. It was very unpleasant. I'd never met this bloke at all and had no dealings with him. But for a couple of hours my wife and I were detained at gunpoint.

"We got away from the police and the CIA and sorted that side of it but that was the least of our concerns. The difficulty has been in disassociating my wife and I from this guy.

"My credit reference went into meltdown. Experian were also an innocent party but these companies have a duty of care to ensure that the information they maintain is as accurate as possible. It is also a statutory duty under the Data Protection Act.

"They have so much information flying through their system – they can run validation checks on some of it, but not on all of it. This happens two or three times a year – they regard it as a business risk.

"It's been a financial nightmare. I wasn't fazed by dealing by lawyers, barristers, policemen and the FBI. But if other people in the same situation didn't have access to the resources I did, they could crumble."

Tom Rowley

Credit reference companies: What they do

* Business has boomed for credit reference agencies as Britain has increasingly swapped cash for plastic.

Companies such as Experian hold information from the electoral roll about where, and with whom, people live and how long they have been at that address.

They have details of loans, as well as defaults on loans, repossessions and bankruptcies. It all adds up to a personal "credit rating" which lenders refer to when they are deliberating whether to issue a credit card, lend money or offer a mortgage deal.

* They can also build up a detailed picture of individuals' spending patterns. They know, for example, if a household has a satellite TV subscription or has accumulated heavy credit card debts.

* Experian has also developed a system its calls "mosaic" for characterising social groups, such as "young well-educated city dwellers" and "residents of isolated rural communities". The way they vote can be analysed by Experian. So can their propensity to commit benefit fraud: "lower income workers [living] in urban terraces" are considered most likely to fiddle the system.

* Experian is now a global credit information group, with operations in 36 countries.

* Experian allows consumers to check their own credit reports to see if they are likely to be refused credit cards or loans. However there have been accusations that an individual's credit rating can in some cases be inaccurate and affected by things outside their control.