The Great War and evolution of central banking in India

The Great War had a phenomenal impact on banking business globally, and served as a precursor to the creation of many central banks worldwide. In the case of India, although the notion of a ‘great Banking Establishment for British India’ (read central bank) dates back to 1836, however, we hypothesize, that this was given impetus with the onset of the Great War. Using indicator analysis and financial stress index this study attempts to explore the relation between the financial crisis prompted by the Great War and the creation of a (quasi) central bank in India. British government needed resources to finance the war and turned to India – the most important settlement outside Europe. Indian banks responded to this rise in public debt (in the form of war loans for the government) by expanding their deposit base by 73 percent during the interwar period. Other banking fundamentals however did not sustain this expansion in banks’ balance sheets. The situation was aggravated in the absence of a fully functional regulatory body to monitor adequacy of reserves, asset-liability maturity mismatch, and money market tightness. This eventually led to a contagion like financial crisis all across India and 83 out of 1100 banks failed during the war years. These bank failures underlined the need for a formal governance framework for Indian banking industry and led to the birth of the quasi-central bank – the Imperial Bank of India in 1921. Later events led to creation of the Reserve Bank of India, the central bank, in 1935.