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Is bank lending special? There are good reasons to ask. Absent good substitutes for bank lending, shocks to the supply of bank loans resulting from changes in monetary policy, bank capital, or bank portfolio preferences will affect the spending of bank borrowers. This implies new ways of thinking about the transmission of monetary policy. In addition to the familiar money/interest rate channel, there will be an additional “lending channel” (Bernanke and Blinder 1988). Moreover, monetary shocks will be borne by the borrowers who depend heavily on banks for loans.

In recent years, some observers have asked whether bank lending is still special, since banks have lost market share to financial markets and other intermediaries. For example, commercial banks’ share of nonfinancial borrowing declined from approximately 36 percent in 1974 to about 22 percent in 1993 (Edwards and Mishkin 1994). In view of such trends, Edwards (1993) has suggested that the notion that banks are special is “obsolete.”

This paper marshals theory and evidence to argue that bank lending is still special. In the first section we begin with some perspective on recent trends on business borrowing. We show that the manufacturing sector has not reduced its dependence on banks, and small firms still borrow almost exclusively from banks. Using a second data set that allows the identification of intermediated debt (but unfortunately not bank versus nonbank), we also show that the large majority of manufacturing firms use only intermediated debt, and that the employment share of such firms is large.

To explain why some firms still rely on banks and intermediaries, the next section reviews the theory of financial contracting. Initially, we follow the literature and distinguish between direct borrowing in public debt markets and intermediated borrowing. (Thus, in this section “bank” and “intermediary” are used interchangeably; a later section will distinguish between bank and nonbank intermediaries.) This theoretical literature argues that well-known, high-quality firms can borrow directly with simple bond and commercial paper contracts, while more information-problematic firms rely on short-term, secured loan contracts with complex covenants. We review a variety of existing studies supporting the view that intermediaries are more efficient than direct lenders at monitoring and renegotiating these complex contracts.

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In the third section we present new evidence in support of this view. First, we report regression results showing that reliance on intermediated debt varies with firm size and other common proxies for agency problems. Second, for firms that borrow exclusively from intermediaries, we show that reliance on short-term debt varies with these same measures of agency problems. Since most short-term borrowing is from banks, this evidence supports the view that bank lending is special for “information-problematic” firms.

In contrast to the second section, in which the discussion did not distinguish among intermediaries, the fourth section argues that banks differ from nonbank intermediaries and bad credit credit cards specifically, insurance companies and finance companies. We argue that because insurance companies have longer-term liabilities, they have a cost advantage in long-term lending, while the short-term liabilities of banks and finance companies make it cheaper for them to lend over the short term. Because short-term loans is a way to control agency problems, smaller, more informationintensive firms will tend to borrow more from banks and finance companies than from insurance companies. And for such firms, finance company loans would appear to be close substitutes for bank loans. But the evidence shows that finance companies specialize in leasing and debt consolidation loans against assets with thick secondary markets, such as automobiles, aircraft, and retail furnishings. Thus, firms with highly specialized or intangible assets may find it difficult (expensive) to substitute finance company loans for bank loans.