Indian Currency and Finance: Chapter VII - Indian Banking

Indian Currency and Finance by John Maynard Keynes is part of HackerNoon’s Book Blog Post series. You can jump to any chapter in this book here. Chapter VII: Indian Banking

CHAPTER VII. INDIAN BANKING

1. In passing from Currency and the Finance of Government to the kindred topic of Banking, we come to a part of the subject where statistics and other information are much less freely available to the outside critic. The published figures are not adequate to tell us much of what we require to know, and the literature of Indian Banking is almost non–existent. I must run the risk, therefore, of sometimes falling into errors of fact, and hope that, if these errors provoke criticism, they will bring to light the true facts at the same time.

2. The Money Market and Banking System of India comprises the following as its four main constituents:—

(i.) The Presidency Banks; (ii.) the European Exchange Banks; (iii.) the Indian Joint Stock Banks; and (iv.) the Shroffs, Marwaris, and other private bankers and money–lenders.

The first two of these constitute what we may term the European Money Market, and the rest, under the leadership of Marwaris and Parsees, the Indian or Native Money Market,—up–country Banks such as the Allahabad Bank and the Alliance Bank of Simla, which are Indian Joint Stock Banks under European management, occupying, perhaps, an intermediate position. The local money markets, outside the main towns in which European business men have offices and where the bulk of the foreign trade is handled, are entirely in the hands of Indians.

3. How close a connexion exists between the two money markets—native and European—how nearly the rates ruling in one agree with those in the other, and how readily capital flows from one to the other, I am not clear. Some evidence bearing on these points was laid before the Fowler Committee of 1898, but such facts are now fifteen years old. In the pre–1899 period it was not uncommon in times of stringency for the bazaar rate to be appreciably lower than the Presidency Bank rate, and the connexion between the two money markets seems to have been very incomplete. The following quotation from a letter by Mr. J. H. Sleigh, Secretary and Treasurer of the Bank of Bombay, written in 1898 (reprinted in the Appendix to the Fowler Committee’s Report), is interesting:—

During the last export season, Shroffs’ 60 days’ sight bills were not obtainable over 8 per cent discount.... This was the rate then ruling in the native bazaar both in Bombay and Calcutta, and that, too, while the Exchange Banks were greedy to receive fixed deposits for short periods at 9, 10, and even 11 per cent per annum, and while the Presidency Banks were straining to meet the demands for loans at 12 and 13 per cent per annum. But there is no singularity in these facts. The same peculiarity has shown itself over and over again during periods of financial pressure; and even at the present moment (November 1898), while money is not by any means tight, there exists a difference of about 2 per cent between the bazaar and the Presidency Bank rates. I have ever found that when the official rate rose abnormally high, the rate in the native market did not respond to the full extent, but generally stopped at 7 or 8 per cent, though the Presidency Banks’ rate might rise to 10 or 12 per cent. The explanation is simple. The Shroffs, who finance nearly the whole of the internal trade of India, rarely, if ever, discount European Paper and never purchase foreign or sterling bills. Neither do they lend money on Government Paper or similar securities, but confine their advances to the discount of hoondees, to loans to cultivators, and against gold and silver bullion. The hoondees they purchase are for the most part those of traders, small and large, at rates of discount ranging from 9 to 25 per cent per annum, but the hoondees they buy and sell to each other, which are chiefly the traders’ hoondees bearing the Shroffs’ own endorsements, rule the rates in the native bazaar, and are generally negotiated, during the busy season, at from 5 to 8 per cent discount. They also discount their endorsements pretty largely with the Presidency Banks when rates are low, and discontinue doing so when they rise above 6 per cent. They also speculate largely at times in Government Paper, especially during the off season, but rarely or ever hold it or lend on it.

I have seen no evidence for supposing that the general conditions outlined in this quotation do not still hold; but in recent years the Presidency Bank rates have not risen above 9 per cent, and occasions for the operation of the tendencies described above have been rarer. The conditions prevailing in the Indian Money Market in the period immediately preceding 1898 were in many respects very abnormal. I suspect that the rates in the two markets may appear to be more different than they really are, and are explicable by the difference of the conditions and of security, subject to which business is transacted. It is, however, plain that the main movements of the interest rate up and down, which result from the central facts of the Indian seasons and harvests, must be the same in both markets, and that the Native Money Market must ultimately depend on the European for additional supplies of cash.

4. As I am chiefly interested in the Indian Banking System, so far as this book is concerned, from the point of view of its effect on the remittance of funds to and from India, I shall be concerned for the most part with what I have called the European Money Market—the Presidency and Exchange Banks. But an Indian writer, in a position to know the facts, could throw much useful light on a question where I must necessarily be content with somewhat doubtful conjecture.

5. The Presidency Bank of Bengal was opened in 1806 and received its charter of incorporation from the East India Company in 1809. The first Bank of Bombay was established under a similar charter in 1840, and the Bank of Madras in 1843. The establishment of these Banks in the other Presidencies put an end to the possibility that the Bank of Bengal might become a Bank for all India. The Presidency Banks had, at first, a semi–official character. At the foundation of the Bank of Bengal, the East India Company contributed one–fifth (the proportion became smaller subsequently) of the capital and appointed three of the directors. Up to the time of the Mutiny the office of Secretary and Treasurer was held by a Covenanted Civilian.

Up to 1862 the Banks had the right of note issue; but this right was so hedged about by a restriction of the total liabilities payable on demand to a certain multiple (at first three times, later four times) of the cash reserve, and of the total liabilities of all kinds to the amount of the Bank’s capital (up to 1839), or of the total note issue to a fixed amount (from 1839 to 1862), that the note issue of the Presidency Banks never became important. In 1862 the management of the note issue was taken over by the Government in the manner described in Chapter III. At the same time the right of note issue by private\ Banks was finally abolished. In 1876 the Government relinquished their share of the capital of the Banks and their right of appointing directors. Since then the Presidency Banks have lost their official character, but remain distinct from other Banks in that they are governed by a special Charter Act (the Presidency Banks Act of 1876).

6. The Presidency Banks have worked from the beginning under very rigorous restrictions as to the character of the business which they might undertake. These restrictions were originally due partly, perhaps, to a feeling of jealousy on the part of the Court of Directors of the East India Company lest the Banks should compete in business (such as foreign exchange) which the Company regarded as its own; but chiefly from a proper wish that semi–official institutions, in a country so dangerous for banking as India, should be conducted on the safest possible principles. An exceedingly interesting history of the restrictions is to be found in Mr. Brunyate’s Account. In 1862 they were greatly relaxed, but the most important limitations were reimposed in 1876. Since that time only minor charges have been effected.

7. The principal restrictions on the Presidency Banks are now the following:—

(i.) The Banks may not draw, discount, buy, or sell bills of exchange or other negotiable securities unless they are payable in India or in Ceylon; this restriction has cut off the Presidency Banks completely from dealing in sterling drafts or any kind of foreign exchange; (ii.) they may not borrow, or receive deposits payable, outside India, or maintain a foreign branch or agency for this or similar purposes, and they are thus prevented from raising funds in London for use in India; (iii.) they may not lend for a longer period than six months; (iv.) or upon mortgage, or in any other manner upon the security of immovable property; (v.) or upon promissory notes bearing less than two independent names; (vi.) or upon personal security; (vii.) or upon goods, unless the goods, or the title to them, are deposited with the Bank as security.

The fifth of these provisions allows a loophole by means of which the rules can be made to work in practice less rigorously than appears on paper. Any two names will satisfy the letter of the Presidency Banks Act; but any two names are not necessarily very good security. After getting two names to satisfy the Act, the authorities of the Banks can then proceed to satisfy the dictates of cautious banking by taking, as well, some of the other kinds of security upon which, technically, they are forbidden to lend. It is an excellent instance of the consequences of an attempt to control banking by an elaborate Act forty years old. The last provision has led, I believe, to the Banks establishing a kind of bonded warehouse for the reception of merchandise. In other cases the borrower’s own mill or warehouse is made to serve the purpose by the expedient of the Bank’s paying the wages of his watchman. Where the personal security of the borrower is obviously good, there must be a temptation to allow him to value the goods generously, rather than to put the Bank to the inconvenience of housing or watching a greater bulk of merchandise.

As some recompense for these restrictions, the Presidency Banks have been allowed to hold a portion of the Government balances without payment of interest. The use of these balances was first granted them in 1862 as compensation for their being deprived of the right of note issue. Up to 1876 the Presidency Banks held, subject to certain conditions, the whole of the Government balances which would have been “paid in ordinary course into Government Treasuries at the places where the head offices and branch offices of the Banks are established.” But on more than one occasion the Banks made difficulties when the Government desired to withdraw large sums at short notice. In 1876, therefore, the Reserve Treasuries were established, and since that time only a portion of the balances has been placed with the Banks.

8. The present constitution of the Presidency Banks is to be explained, therefore, by their long and complicated history. The restrictions under which they work have in the past contributed, beyond doubt, to their stability. The Bank of Bengal has seen the rise and fall of numerous powerful rivals. Only by virtue of its being absolutely precluded by law from the more speculative forms of business, has this Bank survived the half–dozen or more violent crises by which the Indian financial system has been assailed in the last hundred years. And, in spite of the restrictions, the Presidency Banks have shown great vitality and a power of expansion hardly less than that of the Exchange Banks in the happier circumstances of the last decade. But their constitutions are exceedingly out of date at the present time. The considerations which originally gave rise to them are no longer operative;—since the introduction of the Gold Standard, for example, dealing in foreign exchange has ceased to be a highly speculative business. And they do not play as useful a part in the Indian Financial System, as with a different history behind them they might do.

9. The principal statistics of the three Presidency Banks are as follows:—

(a) An exceptional year, due to the excessive abundance of money.

(b) The figures for 1911 and 1912 are not taken from the same returns as the rest, and are not quite strictly comparable with them in one or two details.

These figures do not require much comment. The growth of private deposits since 1900 (rising from £8,500,000 in 1900 to £15,000,000 in 1905 and £24,000,000 in 1912) is very noticeable. This has been accompanied by a fair increase of Capital and Reserve and of Cash. The Presidency Banks publish weekly statements of their affairs, and it is scarcely possible, therefore, that they should “window–dress” their balance sheets. The figures given above refer to December 31, which falls in the busy season; and the proportion of cash held affords no ground of complaint. It should be said, however, that, while the public deposits at the head offices are stable and not liable to sudden reduction, the public deposits at the branch offices stand in a different position and are held literally at call. It is necessary for the Banks to hold a considerable proportion of these in cash at the branches in question, and this arrangement makes the cash held against the private deposits appear in a somewhat more favourable light than it should. It must also be remembered that the Presidency Banks are to a certain extent Bankers’ Banks, and that the other Indian Banks reckon their balances with the Presidency Banks (included in the private deposits) as part of their cash.

10. The two provisions of the Presidency Banks Act which have proved fundamental in their effect on the development of the Indian Banking System are those which prohibit the Presidency Banks from dealing in foreign exchange and from raising funds in London. To transact these two classes of business—though once established they have not limited their transactions to them—a class of Banks has arisen known as the Exchange Banks. Officially a Bank is an Exchange Bank if its head office is located elsewhere than in India; but Banks in this category coincide very nearly with Banks doing the class of business described above. The Indian Specie Bank is the only Indian Joint Stock Bank having a branch office in London; but this is probably in connexion with its business in silver and pearls, and this Bank does not transact any considerable volume of business of the kind undertaken by Exchange Banks.

11. The Exchange Banks proper fall into two groups—those doing a considerable proportion of their total business in India, and those which are no more than agencies of large banking corporations doing business all over Asia. This second group includes the Comptoir National d’Escompte de Paris, the Yokohama Specie Bank, the Deutsch–Asiatische Bank, the International Banking Corporation, and the Russo–Asiatic Bank. These Banks represent in India French, Japanese, German, American, and Russian interests respectively. No figures are published of the proportion of their total business which these Banks transact in India. But I should be surprised if, even in the case of the Yokohama Specie Bank, it would amount to more than five to ten per cent; and in the case of some of them it must be much less than this. In what follows, therefore, I shall leave these five Banks out of account.

In the first group there are six Banks—the Delhi and London Bank (1844), the Chartered Bank of India, Australia, and China (1853), the National Bank of India (1863), the Hong Kong and Shanghai Banking Corporation (1864), the Mercantile Bank of India (1893), and the Eastern Bank (1910). The dates after these Banks give the years when they were established. Of these, two, the Chartered and the Hong Kong Banks, do a very large business in other parts of the East, especially China; but this does not prevent their Indian connexion from being important. The other four are primarily Indian. It is noticeable that no entirely new Exchange Bank now surviving was founded between 1864 and 1910. This is in spite of the fact that most of the above, especially in the last decade, have proved enormously successful from the point of view of their shareholders. The Delhi and London Bank, the oldest established of all, has not shown the vitality or power of expansion of the others; and the Eastern Bank, though it seems to have made a good start, is still too young to pass judgment on. But the shares of the rest, if the issue of bonus shares be allowed for, stand at a premium of about 200 per cent or more. It is probable, however, that it would be exceedingly difficult to start a new Exchange Bank at the present time, except under the aegis of some important financial house already established in a strong position in India. Indian Exchange Banking is no business for speculative or enterprising outsiders, and the large profits which it earns are protected by established and not easily assailable advantages.

12. This summary leads us, therefore, to the important conclusion that the business of financing Indian trade, so far as it is carried out by Banks with their seat in London, is in the hands of a very small number of Banks. They stand, broadly speaking, in an exceedingly strong financial position supported by large reserve funds. In this matter India is now enjoying the fruit of past disasters and of conditions in which the struggle for existence was too keen to allow any but the fittest to survive. If the present spell of prosperity lasts too long, she will no doubt lose it.

13. I shall not attempt any complete account of the activities of a typical Exchange Bank. Much of their business is very like that of any other Bank. But it will be worth while to describe in rather more detail the most characteristic part of their transactions and the part which is most relevant to the topics of this book.

14. In addition to its capital and the reserves accumulated from profits, an Exchange Bank obtains its funds by receiving deposits either for fixed periods or on current account. These deposits are received both in India and in London; but it is a principal object of Exchange Banks to obtain as much as they can in London, and they seek to attract such deposits by offering better terms than an English Bank will allow. On fixed deposits, received for a year or more, 4 or 3½ per cent will be paid; for shorter periods a more variable rate; and on current accounts 2 per cent will be allowed on the minimum monthly balance or on the amount by which the balance exceeds a certain fixed minimum. Apart from the cash, money at call, and investments, which every Bank must hold, a certain part of these funds are employed in making loans either in India or elsewhere. But a large part is employed in the purchase (or discount) of bills of exchange. Some of these bills will be negotiated in London and drawn on India, but the bulk of them will be negotiated in India and drawn on London. A busy Exchange Bank discounts far more of these trade bills in India than it can afford to hold until maturity. But as they are drawn on London houses there is no difficulty in rediscounting them in London. As the majority of the bills are bought by the Banks in India, while cash is received for them, either at maturity or through rediscount, in London, the Banks are constantly in the position of finding themselves in funds in London and of wishing to have funds (for the purchase of more bills) in India. They proceed, therefore, to even up their accounts as between London and India by buying, in London, Council Bills (or transfers) or sovereigns (from the Bank of England or from the agents of Egyptian or Australian Banks) for delivery in India, or, perhaps, silver (though their dealings in silver bullion are probably much less important than formerly) for remittance to India. The question of what determines the relative advantages of these methods has been discussed in Chapter V.

The demand for Council Bills, therefore, chiefly depends on how much new business the Exchange Banks are entering into in India. The method of telegraphic transfers enables them to act with great despatch on receiving advices from their Indian agents. The Indian branches obtain immediately the funds enabling them to take the trade bills, the offer of which had seemed to them to be at sufficiently satisfactory rates to make the transaction taken as a whole worth while. A few weeks later the bills reach England, are duly accepted, and are capable of being rediscounted if the Bank needs additional free funds to buy more Council Bills and turn its money over again in another transaction of the same kind.

We are now in a position to understand what the Secretary of State means when he says that he has sold bills to meet the needs of trade. If he withdraws the convenience of telegraphic transfers or forces the Banks to put themselves in funds in India by sending sovereigns, he causes delay or additional expense in the discounting of bills in India. In other words, Indian traders are less easily able to turn the goods they are exporting into money. On the other hand, if the Indian season is a poor one and the exports fall off, the offer of bills for discount is reduced and the need of the Exchange Banks in London to buy Council Bills correspondingly less.

It is worth noticing that, from the point of view of the London Money Market as a whole, it is a mere difference of machinery whether the Exchange Banks finance the Indian trade by attracting deposits in London and hold the bills themselves, or whether the Discount Houses and London Banks attract the deposits and use them to rediscount bills for the Exchange Banks. In so far as the Exchange Banks can attract deposits themselves without paying too high a rate for them, this alternative is usually the more profitable for them,—especially since, if they are able to hold in this way a considerable proportion of the bills they discount, they can afford to wait for a favourable moment before rediscounting such bills as they have eventually to dispose of. But, apart from private profits, the important point is the extent to which Indian trade is financed by the purchase of Council Bills in London with borrowed money, whether this money is supplied by the depositors in Exchange Banks or by those who rediscount the bills.

15. There is, prima facie, some danger to the stability of the Indian financial system in the fact that its money market is largely financed by funds raised, not permanently but for short periods, in a far–distant foreign centre. In order to judge accurately whether this danger is in any way a real one, it would be necessary to have before us certain facts which are not ordinarily published. We do not know what proportion of the Exchange Banks’ total deposits are held in England; or to what extent those which are so held are fixed for a year or more and how far they are at call or short notice. As is often the case when banking is under discussion in other countries, those who are in a position to know are not in a position to speak, while those who are in a position to speak are not in a position to know. I will make my guess for what it is worth in § 18. In the meantime let us discuss the principle which should guide us, had we knowledge.

It is plain that if Banks were to borrow money at short notice in England and use it in India—certainly if they were to do this on a large scale,—the situation might be dangerous. They might be called on to return what they had borrowed in England, and unable at short notice to bring back what they had lent in India. The principle of which we are in search is, therefore, that the sums borrowed on relatively short notice in either country should not exceed the assets located there. Where, however, bills of exchange between England and India are in question, it is not immediately plain what part of the Banks’ funds may properly be regarded as located in England and what part in India. The answer is, I think, that a bill which has been accepted in England, and is payable there at maturity, is an English asset, wherever it may have been originally negotiated. Thus in the case of Indian Exchange Banks, their deposits in London (other than those fixed for long periods) should be at least balanced by their short–term loans in London, their cash in London, their portfolio of trade bills having a London domicile, and such of their securities as may be readily marketable in London. Similarly their liquid assets in India should at least balance their short–period liabilities there.

16. How far these conditions are as a matter of fact satisfied, it is, as I have said above, impossible to know for certain. The Exchange Banks do not distinguish in their published accounts between their Indian and London deposits. They do, however, give private information to the Indian authorities of their deposits in India and elsewhere respectively in each year. These aggregates for all the Exchange Banks together are published in the Statistics of British India, Part II., and are, therefore, available to the public two or three years after the period to which they refer.

So far as the Indian deposits are concerned, these returns are very valuable. But the aggregate of deposits outside India is as nearly as possible useless. For Exchange Banks of both groups—the Banks primarily Indian and the agencies of huge European institutions doing business in many parts of the world—are lumped together, so that the total includes the whole of the French deposits of the Comptoir National d’Escompte and of the deposits, in whatever country, of the other Banks with Indian agencies enumerated on p. 206. The figures are, therefore, hardly relevant to questions peculiarly Indian; and I will content myself with quoting, from the table given in the official statistics, the total deposits of Exchange Banks made in India, and the cash balances held in India against them.

17. Two facts emerge from this table with great plainness—the rapid rate at which in recent years Exchange Banks have been able to increase the funds raised by deposit in India herself, and the slow rate at which they have thought fit to increase their Indian balances. The position has evidently changed a good deal in quite recent times. It is tantalising to think that two years must elapse before we can know how the Banks stood in these respects last December (1912). The Statistics of British India do not lend their aid to ruder hands than those of the historian.

In the event of an internal financial crisis in India the Exchange Banks are probably depending on the anticipation that they will be able to remit funds from London by telegraphic transfer. In this case they rely on not being hard pressed in India and in London at the same time. An Indian reserve, such as they appear to keep, of from 18 to 20 per cent would be respectable, for example, in England. But in such a country as India, where banking is ill–established and hoarding more than a memory, the proportion held in reserve seems somewhat lower than perhaps it ought to be. Possibly Exchange Banks have already been in smooth waters longer than is for their good. There are famous dates in the history of Indian banking which should serve as a memento mori.

18. When we turn to the assets and liabilities of the Exchange Banks in England we find reason for supposing a much stronger position; for the bulk of the bills of exchange held are probably domiciled in London and may be regarded, therefore, as liquid London assets. The following table sets out the figures relating to deposits, leaving out the Hong Kong and Shanghai Banking Corporation, because, although its Indian business is important, this can only be a small proportion of its total business. I include all the other Banks given in my first group (see p. 207) although the non–Indian business of the Chartered and National Banks cannot be accurately allowed for.

Fixed and Current Deposits (in £1,000,000)

The total cash in hand and at bankers held by these five Banks at the end of 1912 was about £m7¾ I estimate that in 1910 these Banks may have held outside India about £m23 in deposits and about £m5 cash in hand and at bankers.

As to the proportion of these deposits which were held for long periods there is no accurate information. The Chartered and Eastern Banks are alone in distinguishing in their balance sheets between fixed deposits and current accounts. In 1912 the Chartered Bank held £m10½ on current account, etc., and £m7½ on fixed deposit; the Eastern Bank £m½ on current account and £m1½ on fixed deposit. More than half of the deposits of the Banks as a whole are probably held on current account or at short notice. If we are to make a guess, the Banks may have held in 1910 about £13,000,000 on current account outside India; but by no means all of this (in the case of the Chartered and National Banks especially) would be held in London. The question of the amount of the London assets of the Banks does not lend itself to statistical summary. But I do not think that there is the least reason for supposing that the position is not a strong one.

19. The principles which underlie the preceding analysis may be illustrated by reference to a hypothetical balance sheet, simplified, but less simplified than those commonly published.

Acceptances have been omitted in the above, the amount of bills payable is supposed to be deducted from cash, and various minor items are omitted. The “capital employed in India” seems to be (viii.) + (x.) + (xii.) = £m5. The “capital employed in London” is (vii.) + (ix.)–(vi.) + (xi.) = £m5½. The securities and miscellaneous assets (xiii.) + (xiv.) = £m1½, may be regarded perhaps as equally available in either centre. If there is a run in India, assets must be available there in a liquid form equal to (v.). If there is a run in London, liquid assets must be available there equal to (iii.). The second condition, but not the first, is, in this hypothetical example, fulfilled. If the Bank had to remit funds back from India to London, this would be most simply effected by not entering into new business under (ix.). It would not then be necessary to buy Council Bills, and the trade bills already bought under (ix.), being rediscounted or allowed to mature in London, would swell the available funds there automatically. If it were possible to call in loans in India and reduce (viii.), then it would be possible to buy more trade bills under (ix.) in India (or Government sterling drafts if trade were depressed), without having to buy Council Bills in London, and these trade bills could then be rediscounted in London. If the Exchange Banks are remitting funds back to London, this shows itself, therefore, in a poor demand for Council Bills; and conversely when they are remitting funds to India, there is a strong demand for Council Bills. Thus the weakness of the demand for Council Bills in times of depression (and the strength of the demand for Government sterling drafts) partly depends on the action of the Exchange Banks. What their action would be in a situation of acute stringency bordering on financial panic, it is not easy to predict.

20. So far the only apparent element of danger in the banking position seems to lie in the growth of deposits attracted by the Exchange Banks in India without a corresponding growth in their Indian cash reserves. It would be a good thing if the Exchange Banks were compelled to distinguish in their balance sheets between their Indian and extra–Indian business, much in the manner set out in the hypothetical balance sheet on p. 218, except that for “London” “outside India” would have to be substituted. They should also distinguish, as two already do distinguish, between fixed deposits and accounts at call or for short periods. When, as in the case of the Exchange Banks, we have to deal with a small number of Banks of established position, an insistence on due publicity, rather than compulsion or regulation in matters of policy, is likely to be the proper remedy for any weaknesses which may possibly exist.

21. The next section of the Indian banking world comprises the Indian Joint Stock Banks, i.e. those Banks, other than the three Presidency Banks, registered in India and having their head offices there. This is a confusing group, because a great number of small money–lending establishments are registered as Banks under the Indian Companies Act—in 1910–11 492 businesses were classified as Banks. The official statistics separate off, however, those of the Banks proper which are of any considerable size,—those, namely, which have a paid–up capital and reserve of at least 5 lakhs (£33,000).

The earlier Banks, coming under this description, were usually under European management. Out of seven existing in 1870, only two now survive,—the Bank of Upper India (1863) and the Allahabad Bank (1865). Between 1870 and 1894 seven more Banks, conforming on the whole to this same type, were founded, of which four now survive,—the Alliance Bank of Simla (1874), the Oudh Commercial Bank (1881), the Punjab Banking Company (1889), and the Punjab National Bank (1894). All these. Banks are on a very small scale compared with the Presidency and Exchange Banks; but they are distinguished in type from most of the more recent creations.

Between 1894 and 1904 no new Banks were founded with as much as 5 lakhs of paid–up capital. But since 1904 there has been a great outburst of fresh activity, and a type of Bank new to India has become important. The way was led in 1904 by the foundation of the Bank of Burma. This Bank failed in 1911, two directors and the general manager being found guilty of cheating and sentenced to imprisonment in 1913. In 1906 three Banks were founded, all of some importance,—the Bank of India (under important Parsee auspices), the Bank of Rangoon, and the Indian Specie Bank. Until 1910 these three Banks remained alone amongst the new creations in having a paid–up capital in excess of 15 lakhs (£100,000). Since 1906 numerous Banks have been started, amongst the most important of which in respect of paid–up capital may be mentioned the Bengal National Bank (1907), the Bombay Merchants’ Bank (1909), the Credit Bank of India (1909), the Kathiawar and Ahmedabad Banking Corporation (1910), and the Central Bank of India (1911).

The main object of most of these Banks is, of course, to attract deposits (though some of them are almost as much concerned at present with placing a further part of their unissued capital). For deposits fixed for a year the rate offered varies, as a rule, from 4½ to 5 per cent, the newer creations generally favouring the higher rate. Some Banks offer 6 per cent. About the rates for shorter periods there is more vagueness. On current accounts 2 per cent is generally allowed, though the eagerness of some of the newest Banks has led them to offer 2½. I have the advertisement before me of a Bank which offers 3 per cent on the daily balance, and up to 6 per cent on sums deposited for longer periods; at the head of the advertisement appears in large letters—Capital, Rs. 50,000,000; but it appears below that applications for shares are invited, and the paid–up capital is probably negligible. Some Banks advertise such advantages as “Special Marriage Deposits, 50 per cent added to Principal in five years’ time.”

4½ per cent on deposits fixed for a year and 2 per cent on current accounts in excess of a certain minimum are very likely reasonable rates to offer in Indian conditions, provided that the funds thus attracted are not used for speculation and that adequate reserves are maintained in a liquid form. It is in this respect that the more substantial of these Banks are chiefly open to criticism. The official statistics are, unfortunately, very much out of date. But for the Banks which had a paid–up capital and reserve of at least 5 lakhs the available figures up to 1910 are as follows:—

Indian Joint Stock Banks

22. These figures reveal, in my opinion, an exceedingly serious state of affairs. If they could be brought up to date, they would probably appear even worse. As late as 1900 these Banks were comparatively insignificant. Since that time they have succeeded in attracting so large a volume of deposits as to make them an important part of the banking system of the country. Only six of them date back long enough to remember any real financial crisis in India (for the depression of 1907–8 was not accompanied by the symptoms of financial crisis). Growing up in smooth times, they have thought more of attracting deposits than of retaining cash reserves; and in 1910 we find sixteen Banks with deposits of £17,000,000 and cash reserves of not quite 11 per cent. Even of these reserves the greater part is probably held by the older and more established of the Banks belonging to this class. In the case of the smaller Banks, dealing, as they are, with clients to whom banking is a new thing and in a country where hoarding is still dominant, the cash balances seem, from the available indications, to be hopelessly inadequate; and it is hard to doubt that in the next bad times they will go down like ninepins. If such a catastrophe occurs, the damage inflicted on India will be far greater than the direct loss falling on the depositors. The growth of banking habits in India is, of course, of the utmost importance to the country’s economic development. A startling series of failures will do much to retard it.

In this connexion the history of the Bank of Burma, the first Bank of the new order to be founded, is instructive. This Bank was started in 1904 under European management by a firm engaged in floating oil companies and other highly speculative enterprises. The Bank’s capital was £117,500, and by 1911, when it failed, deposits had been attracted to the extent of £792,701, a large part of which is said to have come from Bombay and Calcutta. To obtain these deposits the Bank had offered interest at the rate of 6 per cent for deposits placed with it for a year; and many persons, it seems, were deceived by its title into believing that it was in some sense a Presidency Bank. In the autumn of 1911, after a year in which the Burma rice crop had been good and had sold at very high prices, and when the province generally was prosperous, the Bank failed. The balance sheet turned out to be false, and one–third of the assets had been advanced against worthless security to a firm in which the directors were interested.

23. Both in the case of the Exchange Banks and in that of the Indian Joint Stock Banks, the “Cash Balances” include, I think, balances held at other Banks. It is impossible, therefore, to summarise accurately the figures for the Indian Banking System as a whole—Presidency Banks, Exchange Banks, and Joint Stock Banks together. The figures given below state accurately the total of private deposits; but in the total of cash balances some items must be counted twice over.

(a) An exceptional year.

The steady deterioration of the position, as shown in the above figures, is exceedingly marked. These figures flatter the Banks, rather than the reverse. For I have excluded the Public Deposits (amounting in 1910 to £2,820,000), and have included the whole of the cash balances (at the branches as well as the head offices) held by the Presidency Banks against them. If the figures could be worked out accurately, the present proportion of cash available against the private deposits would come out, I suspect, lower by far than appears superficially from the above table.

24. To complete the figures of Indian deposits, it will be useful to give at this point the deposits in the Post Office Savings Banks, which have increased at a great rate, though not so fast as deposits in Banks, since 1900:—

As in England, the Government do not maintain any specific reserve against these deposits. They are treated as unfunded debt and used for capital expenditure. It is important, therefore, to remember that the Government now hold in India nearly £14,000,000 of unfunded debt repayable at short notice to 1,500,000 depositors. This constitutes a not negligible claim on their general reserves.

25. The figures of the preceding paragraphs, in their cumulative effect, suggest the following reflection. Apart from any deterioration in the proportion of reserves held, the question of Indian deposits is now important. They stand for the first time at a figure which is large in relation to the total trade of the country and to the resources of the Government. If the Banks get into trouble, there will be much more far–reaching effects than could have been the case formerly. This is quite apart from the question whether they are more likely to get into trouble than formerly. The question of the reserves they hold matters, therefore, more than it used. The information which I have been able to convey in this chapter is exceedingly incomplete. But, such as it is, it provides strong prima facie grounds for doubt and dissatisfaction.

26. The last group of Banks for discussion—since I have no precise data relating to the private and unincorporated bankers or money–lenders—consists of those numerous institutions registered as Banks under the Indian Companies Act, but with a capital insufficient or with activities too mixed for inclusion in the list of Indian Joint Stock Banks proper, dealt with above.

The available statistics (approximate) are as follows:—

There are no statistics of their deposits. While the capital of these Banks has increased rather rapidly since 1907, the above figures show that it is not yet large.

Our interest in these Banks, however, arises not so much out of the banking business which they may possibly transact, as out of certain, almost Gilbertian, characteristics calculated to bring the name and profession of banking into derision or disrepute. These Banks have discovered that there is, or may be, a useful ambiguity in the public mind between nominal capital and paid–up capital, and that nothing is cheaper than to increase the former. When, therefore, a Bank is registered, its promoters may just as well put down as its nominal capital sums ranging from £100,000 to £1,000,000 as anything else. One comic opera Bank registered in Calcutta in 1910 put down £20,000,000, without having at the time of the last return any paid–up capital at all. Apart from this exceptional venture, the 38 Banks registered in 1910–11 had between them a nominal capital of £1,306,000 and a paid–up capital of £19,500. With enormous nominal capitals they combine high–sounding titles—the Bank of Asia, the East India Bank, the Hindustan Bank, the United Bank of Commerce, and so forth. Once established, their activities are not limited. One of these Banks has included in its operations coach–building and medical attendance.

27. Plainly these ventures are not to be taken too seriously. But the recent activity of their promoters has raised some discussion in India as to whether it would not be for the public good to restrain them by legislation. In this matter, as is the case in so many (her governors knowing no other model), the legislation of India has followed the lines of Great Britain’s. Just as in this country there is no special law relating to the incorporation of Banks, so in India Banks are registered under the ordinary Joint Stock Companies Act. As a Bill to amend this Act has been to the front for some time, discussion has naturally centred round the question whether this opportunity should not be taken of introducing some suitable restrictions relating specifically to Banks. While I am inclined to think that it would be more convenient to deal with this matter in a separate Bill, the important point is that decided action of some kind should be taken with the least possible delay. The Upper Indian Chamber of Commerce, in reply to an inquiry from Government in 1910, answered, very wisely, as follows:—

The Committee feel very strongly that something more is needed (i.e., than in other Companies) in the case of Banks where the capital and confidence, not only of the shareholders but of the depositors, are involved. New Banks are springing up with alarming rapidity, with little share capital subscribed; these Banks are trading on the confidence of the depositor who is little versed in money matters but is attracted by the name “Bank” and wishes to earn interest on his savings.... The fear is that if one of these mushroom growths fails, others will follow, and the timid depositor, unable to discriminate between the sound and the unsound concerns, will make haste to get his money back from whatever Bank it is in, and his confidence in banking institutions thus rudely checked will take years to win back.

Various suggestions have been made as to what restrictions would be proper. It has been proposed that it should not be permitted to combine banking operations with other businesses; that the accounts of Banks should be regularly audited and the results published; that fairly detailed accounts should be published in the local official Gazette; that all institutions calling themselves Banks should be required to publish certain specified particulars at the head of every advertisement; and that capital and reserves should bear a certain proportion to liabilities before dividends may be paid. The abuse of a great disproportion between nominal and paid–up capital could be cured by a stamp duty on registration proportioned to the nominal capital. Provisions for due publicity will probably lead in the long–run to the best results—though care must be taken that the form for publication of accounts is well suited to bring to the light what is most relevant. Regulations of other kinds are apt to have hampering results which cannot be easily foreseen. During the infancy of Indian banking, nevertheless, it will very likely be wise to have some precise rule as to the kind and amount of the reserves.

28. In conclusion, something must be said about proposals for a State Bank. This is a proper subject for inquiry by a Royal Commission. I am not prepared to discuss it here in detail.

The question is an old one. In 1836 “a large body of merchants interested in the East Indies” submitted to the Court of Directors of the East India Company a project for a “great Banking Establishment for British India.” Such a Bank, “confining its transactions strictly to Banking principles and business,” and “established by Act of Parliament and possessed of adequate capital, would, under judicious management and control, become an instrument of general good by facilitating the employment of a portion of the redundant capital of this country (England) for the general improvement of Indian commerce, giving stability to the monetary system of India, and preventing those occasional fluctuations to which it is at present subject, and also by affording the Company facilities and advantages in their future financial arrangements.” It was also to “facilitate the receipt of the revenue and its subsequent diffusion through the various channels of the public expenditure, furnish the remittance to Great Britain of the sums required there for the Home Charges, and enable the East India Company to act up to the instruction of the legislature by keeping their Government entirely aloof from that interference with the commerce of India which the present system of remittance involves.... At present the basis of the Bank of Bengal is too narrow for such a customer as the Government.” I quote this from the Account of the Presidency Banks by Mr. J. B. Brunyate, who remarks on its appropriateness to present conditions. From 1860 to 1876 the possibility of the Bank of Bengal’s developing into a “Bank of India” was constantly in the air, successive financial Members of Council being not unfriendly to the idea. In 1867 a specific proposal for the amalgamation of the three Presidency Banks was laid before the Government of India in a memorandum of complete grasp and mastery by Mr. Dickson, celebrated (in his own time) for pre–eminent ability as Secretary and Treasurer of the Bank of Bengal. The Viceroy’s minute was unfavourable. “I submit,” he wrote, “that it is not for the interest of a State that a great institution of the kind should grow up for all India, the interests of which may in time be opposed to those of the public, and whose influence at any rate may overshadow that of the Government itself. A Bank of such a character would be very difficult to manage. Few men in India would be found equal to the task. And as regards the interests and convenience of the merchants of Bombay and Madras, surely it is only natural that they should prefer separate Banks for those important centres of commerce.” The Secretary of State’s sole contribution to the discussion—no need to name him, it is the eternal Secretary of State speaking, not a transient individual—was as follows:—

Any proposition for changes of a fundamental character, such as the establishment of a Central State Bank, or a return to the system of Government Treasuries, which may hereafter be taken into consideration, must be viewed in its general bearings, and not with special reference to the circumstances, of a particular Presidency, or of a particular crisis.

The project was smothered in the magnificent and empty maxims of political wisdom.

Before the Fowler Committee of 1898, there was some desultory discussion of proposals for a Central Bank of India, which were supported by a few of the witnesses; but, apart from Mr. Hambro’s memorandum, no attempt was made to deal with the question in detail.

29. At the present time the arguments in favour of a State Bank for India are very strong,—far stronger than they were in 1867 or even in 1898. The Government have taken over so many of the functions of a Central Bank, that they cannot wisely neglect the rest. A note issue of growing importance, the management of the Government’s cash balances, the regulation of the foreign exchanges,—all these are controlled together and treated as a whole in a compact and admirably conceived scheme. But other benefits cannot be obtained easily, so long as these functions are utterly divorced from those of banking proper. I summarise the arguments thus:—

(i.) The existing divorce between responsibility for the note issue and that for banking generally is contrary to modern banking practice, and is, in several respects, a source of weakness.

(ii.) In particular it leads to the keeping of two distinct reserves—the Government’s reserves and the bankers’ reserves—with no clearly defined relation between them, so that the reserves of the latter may be insufficient, without the assumption by the former of the fact or the machinery of responsibility.

(iii.) It leads also to a want of elasticity in the system, since in modern conditions this elasticity is most commonly provided by exactly that co–operation between banking and note issue which is lacking in India.

(iv.) The absence of a State Bank makes it difficult for the Government to use its cash balances or any other part of its liquid funds to the best advantage,—since it cannot prudently place the whole of its free resources in the hands of a private institution.

(v.) The absence of a central banking authority leads to a general lack of direction in the banking policy of the country: it is no one’s business to look at the matter as a whole, to know the position of the market’s component units, or to enforce prudence when it is needed. There is a multiple reserve system in theory, but hardly an adequate one in fact; and a danger exists that every one is reckoning, in a crisis, upon every one else.

(vi.) The absence of the advice and experience, which the officers of a State Bank would possess, is a source of weakness to Government itself. There are no high officials whose business it is to make finance the chief study of their life. The Financial Secretaryship is an incident in the career of a successful civilian. A Financial Member of Council is apt to come to the peculiar problems of his office with a fresh mind. Thus the financial officers of Government spend five years or so in mastering a difficult subject and have then reached a seniority which warrants promotion to duties of some other kind. So far as the Government of India is concerned, questions of finance and currency are in the hands of intelligent amateurs who begin with the timidity of ignorance and leave off just when they are becoming properly secure of their ground. It is not astonishing that the centre of power in these matters has tended to gravitate to the India Office and the India Council in London. For the officials and advisers of the Secretary of State have grown up in familiarity with the problems of Indian currency. Control from the India Office is always looked on, from an instinct often founded on wisdom, with jealousy and with suspicion; but in\questions of currency they are likely, as things now are, to have the wider knowledge and experience. Yet the element of continuity supplied by the India Office—though, as I read the history of the last decade, it has been invaluable in guiding the evolution of the currency—is no proper solution of the difficulty. With Indian banking this authority cannot be adequately in touch, and it would be much better if trained experience were to be found in India herself. It is a remarkable thing that the two classical pronouncements on the fundamental problems of Indian Finance, which have stood the test of time—Mr. Dickson’s, in 1867, on the question of a Central Bank, and Mr. A. M. Lindsay’s, in 1878 and subsequently, on the regulation of a Gold Standard—should both have come from Secretaries of the Bank of Bengal, not from high officials of State. (Yet this last argument for a State Bank, though I have amplified it in my summary at greatest length, is not at all the most important. The arguments given first are those which govern the question.)

30. On the other hand, a fairly good case can be made out against a State Bank. Several of the defects, outlined above, could be remedied, in part at least, by less drastic proposals. The reasons on this side are mainly, nevertheless, those of conservatism and of caution (or timidity). The question, as soon as one attempts to frame practical suggestions, bristles with difficulties. The Government are naturally  afraid of so troublesome a proposal—and one so far removed from what they are used to; while there is no important body which is sufficiently interested in forcing it on their attention. The Banks fear a possible rival; merchants are content with present prosperity; and no one else knows anything about it. I shall be astonished, therefore, if action is taken while times are good. Perhaps we may have to wait for the lessons of a severe crisis. Only under some such strong influence as this is it likely that the responsible Government will nerve itself to the task, or the business community acquiesce in it.

31. If some day sufficient constructive energy is stirred into activity to undertake the task, let the framers of the new Bank’s constitution put far from their minds all thoughts of the Bank of England. It is in the State Banks of Europe, especially in that of Germany, or in those, perhaps, of Holland or Russia, that the proper model is to be found.

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Keynes, John Maynard, 2015. Indian Currency and Finance. Urbana, Illinois: Project Gutenberg. Retrieved May 2022 from https://www.gutenberg.org/files/49166/49166-h/49166-h.htm

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