How are commercial banks different?
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. But why are banks especially well positioned to perform this monitoring activity? Several of the reasons below focus on the unique ability of a bank to offer demand deposits. Black (1975) has argued that
