Fama offered the following observation on the uniqueness of banks commercial lending activities. Bank loans represent a short-maturity funding source that requires frequent renewal. Therefore, banks are on the front line of establishing and continually reevaluating the creditworthiness of firms. A bank s willingness to lend to a firm is a valuable signal that is readily observed by the capital markets and by other potential creditors to the firm, as well as by the firm s clients and suppliers. Fama notes that it is common practice for many firms to incur the cost of establishing a line of credit with a bank, even though they may never intend to use it, in order to ensure that this signal is being sent.
Bank loans play a similar role in establishing the creditworthiness of households.
Several of the reasons below focus on the unique ability of a bank to offer demand deposits. In addition, a bank provides other financial services to a corporate client, such as managing its accounts receivable or managing the risk of a portion of its asset portfolio. In this case, the bank would choose to refinance the firm s debt rather than force the liquidation of the assets. This aspect of relationship lending is obviously of value to the firm, and it applies equally well to households. There are two issues here.