Dutch forces in the Netherlands East Indies were severely weakened by the defeat and occupation of the Netherlands itself, by Nazi Germany, in 1940. The KNIL was cut off from external Dutch assistance, except by Royal Netherlands Navy units. The KNIL, hastily and inadequately, attempted to transform into a modern military force able to protect the Dutch East Indies from foreign invasion. By December 1941, Dutch forces in Indonesia numbered around 85,000 personnel: regular troops comprised about 1,000 officers and 34,000 enlisted soldiers, of whom 28,000 were indigenous. The remainder were made up of locally organised militia, territorial guard units and civilian auxiliaries. The KNIL air force, Militaire Luchtvaart KNIL (Royal Netherlands East Indies Air Force (ML-KNIL)) numbered 389 planes of all types, but was largely outclassed by superior Japanese planes. The Royal Netherlands Navy Air Service, or MLD, also had significant forces in the NEI.

During the Dutch East Indies campaign of 1941–42 most of the KNIL and other Allied forces were quickly defeated. Most European soldiers, which in practice included all able bodied Indo-European males, were interned by the Japanese as POWs. 25% of the POWs did not survive their internment.

A handful of soldiers, mostly indigenous personnel, mounted guerilla campaigns against the Japanese.

During early 1942, some KNIL personnel escaped to Australia. Some indigenous personnel were interned in Australia under suspicion of sympathies with the Japanese. The remainder began a long process of re-grouping. In late 1942, a failed attempt to land in East Timor, to reinforce Australian commandos waging a guerrilla campaign ended with the loss of 60 Dutch personnel.

Four "NETHERLANDS EAST INDIES" squadrons were formed from ML-KNIL personnel, under the auspices of the Royal Australian Air Force, with Australian ground staff.

KNIL infantry forces (much like their counterparts in the UK), were augmented by recruitment among Dutch expatriates around the world and by colonial troops from as far away as the Dutch West Indies. During 1944–45 some small units saw action in the New Guinea campaign and Borneo campaign.