Accurate and rapid removal of transformer faults is related to the safe and stable operation of power system. The identification of magnetizing inrush current is a vital problem in transformer protection. In order to detect internal fault current from inrush current correctly and prevent incorrect operations of relays. By analyzing and summarizing the difference characteristics in frequency domain between fault current and inrush current, this paper proposed a novel inrush currents identification criterion based on least-square matrix pencil, using transformer differential current as detection signal. The matrix pencil algorithm is used to calculate the harmonic component of transformer current. And then entropy of current content and decay factor is computed to discriminate the inrush current. Simulation results show this scheme reliability and effective, can precisely identify the inrush current from the inner fault current. On this basis, key issues in the field are provided for the further research and engineering applications.