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How free banking ended in India

Under British rule, banks in India initially issued notes competitively. That changed because of James Wilson. Wilson is best known today as the founder of the Economist magazine, but he was a man of many accomplishments, including being a successful factory owner; a founder of one of the corporate ancestors to today's Standard Chartered Bank; and member of Parliament. One of his daughters married Walter Bagehot, who would later become the third editor of the Economist and who wrote a fine appreciation after his father-in-law's death.

In 1857 and 1858 the Sepoy Rebellion against the British East India Company nearly overthrew British rule in India. In response, the British government took over the rule of India from the company. It inherited a fiscal mess. The rebellion had reduced tax revenues while requiring a large increase in expenses for its suppression. The British government needed somebody to straighten out India's government finances, and it picked Wilson because during his time as a member of Parliament he had worked capably in bodies dealing with Indian affairs and finance. Wilson was appointed Financial Member (like minister of finance) in the Indian colonial government and sailed to Calcutta, then the capital of India, in 1859.

Wilson proposed spending cuts, tax increases, reforms in budgeting procedures, and a government monopoly of note issue. Wilson’s case for a government monopoly of note issue was that (a) notes enabled a considerable saving of cost over using coins; (b) the government would reap a large part of such savings; (c) the savings for all would be largest if the notes were legal tender; (d) it would be inappropriate for bank-issued notes to be legal tender; (e) government notes could be issued according to procedures that would make them secure, in fact more so than bank-issued notes; (f) a uniform, reliable, legal tender currency would contribute to government revenue both by promoting faster economic growth and by generating seigniorage; and (g) issuing notes was not a necessary part of the business of banks.

Earlier in his career, in the book Capital, Currency, and Banking, Wilson had defended freedom of note issue in Scotland, but had also stated the view that  issuing notes was not a necessary part of the business of banks. In India at the time he proposed a government monopoly, note issue was quite small compared to coinage in circulation and notes were little used outside the three main centers of British administration–Calcutta, Madras, and Bombay. Wilson evidently considered that the benefits of a government monopoly of note issue were preponderant in the Indian case.

Wilson died, apparently of a tropical ailment, in 1860 and was buried in Calcutta. His unmarked grave was rediscovered nearly a century and a half later by an Indian tax official with an interest in history. Wilson's successor as Financial Member adopted Wilson's proposal in slightly modified form in Act 19 of 1861 and note issue became a government monopoly in India starting March 1, 1862.


  1. The revolt in India was, in part, provoked by the wild spending (on "internal improvements") of the East India Company government (the Company had been "freed" from the control of its shareholders by Acts of Parliament in the 1700s and was a company in name only) – this wild spending led to heavy taxation which was (quite understandably) resented.

    However, I did not know of James Wilson's role afterwards – I should have known and I did not know. So this is useful.

    Even as late as the 1920s there was a strong movement for proper gold money in India (rather than various government backed frauds) – Paul Johnson (in "Modern Times") briefly mentions how such a development was prevented (by the usual suspects – Bank of England, Federal Reserve and so on).

    The problem persists to this day.

    The Indian people want gold (they always have) and the government (regardless of who the government is) tries to insist they use something else.

  2. Wilson doesn't mention (h) inflating is easier than raising taxes, and a monopoly ensures that less inflationary issuers have no competitive advantage. Did he address this concern?

    What was Wilson's rationale for (d), other than his personal sense of propriety? If the state taxes a percentage of my sales or income, why wouldn't it accept a percentage of any currency I accept, including competitively issued notes? Does the tax collector expect me to accept worthless notes out of spite? If I accept worthless currency, have I received taxable income?

    1. If you are keen to find out, you can read the links to Wilson's writings that I supplied.

        1. Martin, you know blogs exist to cause trouble, not to save it! (I have a possible future post in mind about Internet commentary that I may call "World's Biggest Bar Room.")

  3. It should be remembered that James Wilson (at least as far as the United Kingdom was concerned) was still better than Walter Bagehot.

    When one reads the Economist publication from when Wilson was editor (or the other writings of Wilson – at least concerning the U.K.) there is a strong sense that the government should be reduced in size and scope – rolled back.

    This goes under Bagehot – the Economist becomes more of an establishment publication, making noises in favour of "Social Reform" (i.e. the expansion, not the rolling back, of government). Bagehot puts it this way in his "classic" work on the "English Constitution" (and people say that only outsiders make the mistake of calling the UK "England") where Bagehot says that "we" should "concede whatever it is safe to concede" – the basic attitude it wrong (he is assuming that the growth of the state is inevitable and just trying to moderate the rate of growth – rather than seeking, as Wilson did, to roll back the state).

    Sometimes Bagehot went too far even for the Establishment – for example his support for bank bailouts (an attitude that disgusted the then Governor of the Bank of England). Although, it must be remembered, that Walter Bagehot's position is a moderate one compared to the insanity of today.

  4. If a monetary rule is followed, note issue is unlikely to become a serious problem, since price level would remain constant.

    I believe that initial central banking efforts were broadly price neutral, not inflationary. This was particularly true of the India rupee, which maintained strong parity with USD and the British pound till independence. Since independence, with expansionary socialist policies, the balanced budget concept was forgotten and the Indian rupee has been trashed. Its purchasing power is now probably less than 1/1000th of its 1947 value.

    The key advantage of the private note issue system is that it stops governments from trashing the currency. This is point (h) made by Martin Block, above: "inflating is easier than raising taxes".

    It is a shame that otherwise sensible thinkers failed to anticipate government failure: the public choice incentives of bureaucrats and politicians.

    Private banking – through competition – eliminates perverse incentives to deflate. That is its greatest merit. I strongly recommend that India return note issue to private banks.

    1. It is a terrible mistake to aim at a stable "price level" – it is the mistake of Irving Fisher, the idea that a rising money supply does not matter as long as the "price level" (judged by some index) is stable. This theory is just wrong – flat wrong.

  5. Paul, there are basically three options in this area. I'm using "centrally planned" language to illustrate: a) expand the quantum of money "optimally" to maintain a constant price level, b) fix the quantum of money (e.g. gold), leading to perpetual reduction in prices, and c) expand the quantum of money excessively, leading to price inflation.

    I can't clearly visualise which option will emerge in a competitive banking system, but would imagine (a) to be a likely candidate. I imagine that (c) will almost certainly be eliminated since consumers hate it. Option (b) is likely to dampen investment and investors are likely to prefer to do business with that bank which keeps price levels constant.

    On balance, (a) will emerge as the more likely scenario in a private competitive market, and it also best defends the interests of both consumers and investors.

    Why would a stable price level be "wrong", if it preferred by both consumers and investors?

  6. Sanjeev – "a" would be terrible. Expanding the credit money supply (even to the cry of "well prices in the shops are not going up") has been responsible for every boom-bust in the modern world. It is expanding the credit-money supply (and the malinvestments it creates) that is the problem – not the "price level" on some index. Irving Fisher was wrong – 1921 and 1929 prove him wrong (if people demand "empirical evidence" not "just" economic law, i.e. reason).

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