Are Banks Still Important for Financing Large Businesses?

Over the past twenty-five years, an increasing number of financial transactions have moved from banks to the securities markets. During the same period, competing financial institutions have expanded the range of traditional banking services they offer customers. Both thrifts and finance companies now provide loans to small businesses, and money market mutual funds offer close substitutes for checkable deposits. This shift toward the financial markets and nontraditional financial institutions has significantly reduced the role of banks in providing credit to U.S. businesses. The decreasing reliance on bank credit has been most pronounced among large corporations, which now tend to turn to the securities markets to fulfill their short- and long-term financing needs. These changes have led many people to question whether banks remain important in the financing of large corporations. In this edition of Current Issues, we argue that they do. Despite their declining role in the provision of credit, banks continue to perform a critical function in providing liquidity to large corporations, particularly during periods of economic stress. To support our point, we analyze the effects of last fall's economic turmoil in the securities markets on the borrowing practices of large corporations. Our analysis shows that during this period, borrowing in the com- mercial paper market—the primary source of short- term funding for large corporations—grew too expen- sive, causing many borrowers to turn to bank loans until interest rates stabilized. By providing a backup source of liquidity, banks helped insulate many large corpora- tions from market shocks.