As the FBI agents are investigating the case, with each new body they find they discover a large patch of skin has been removed from each corpse. They're stumped as to the purpose of this. Why is this killer removing patch of skin? Also, they come to the realization that the victims are generally a little overweight, in fact when discussing the victims, one of the FBI agents, I'm not sure if it was Clarice or not, uses the term “roamy” …I guess to indicate they we're bigger girls with wide hips.
When they finally introduce us to Buffalo Bill in the movie, you will notice there is a mannequin on which he's trying to piece together a dress. Well, that dress is made up of the skin of his victims. He is removing skin from the bodies of his victims and sewing them together to make a dress. That leads to the answer to your question.
One of the things that Buffalo Bill needed was for his victims to have skin that he could work with. The line you referenced was said by him to the senator's daughter he had in the pit. Unless she rubbed the lotion on her skin, he was going to spray her with the hose again. Much like a farmer fattening up livestock before he slaughters them, Buffalo Bill was forcing his victims to moisturize their skin so it would be more supple and dry out less quickly as he was trying to make his dress from pieces of their body.
In terms of the psychology of a serial killer, having some souvenir of their successful conquest (control) is a very common theme. Many serial killers simply do it out of a pathological need for power and control over others. These types of killers most often keep a souvenir of some type to remind them of their prowess... much like a trophy won for an athletic achievement.
I'm not a doctor, only someone who has survived a malignant narcissist and have read everything I can find on the subject after my own experience with evil. It is my belief that Buffalo Bill would be classified as “dark triad" personality, at the far end of the narcissistic spectrum. Besides having little or no empathy conscience, guilt or remorse, extreme narcissists like Buffalo Bill see human beings only as objects, props to be used for their pleasure. In fact, that issue was addressed when senator Martin, the mother of the kidnapped victim that was in the pit, went on TV and appealed to the kidnappers humanity by describing her daughter Catherine as “kind and sweet" and did her best to humanize her.
After seeing Senator Martin speak, the female agent watching the TV broadcast with Clarice said “that was very smart"…and Clarisse said “she's trying to get him to see Catherine as a human being and not an object”. The entire scene was an acknowledgment that the psychological profile used as a basis for the Buffalo Bill character was one of an extreme narcissist, a dark triad personality who not only exhibits extreme narcissism… but also Machiavellianism and sadism.
One of the reasons the movie was so memorable, besides the extreme depravity of Buffalo Bill and Hannibal Lectern, was the way they try to understand the psychology of the killer to establish a psychological profile…which they hoped would help them catch him or her. The idea of psychological profiling was a fairly new concept, not only to the public, but to law enforcement in general, and made the movie much more interesting and suspenseful
Although I do not like to watch movies with gratuitous violence and will turn off any movie where the violence is not used for the purpose of establishing a plot or the understanding of the nature of the subject, this movie was so well done… and only used violence and horror to advance understanding of the disordered mind of both Buffalo Bill and Hannibal Lecter, it was too compelling to turn away from. It is absolutely one of my favorite movies.
He says this line as an instruction. Clarice reveals earlier that he keeps his victims alive for a few days and starves them in order for the skin to be loosened to make removal easier. The idea behind the lotion as that on top of the skin being loosened the lotion enabled the skin to remain soft and malleable - so he can shape it to be the suit. The connection with the hose is if you look down the well you will notice its damp and cold and that a hose nozzle is placed over he lip of the well. It is as if Bill uses the hose as a punishment for failing to rub the lotion on their skin. He refers to Catherine* as “it” so it can be assumed he did this with all of his victims.
This idea makes it easier for him to kill the girls as by dehumanizing them, he doesn’t see himself as such a monster. This can be linked with the scene where the senator is talking to Bill in a press conference and she keeps repeating Catherine’s* name as if to make her seem more human - Clarice picked up on this fact as well. This quote is very famous and has been parodied multiple times for example: the song ‘lotion’ by the Greenskeepers plays on the ideas presented by Buffalo Bill and Dr Lecter in the film and makes it sound as though the singer has the combined personalities of both of them.
The secondary villain of Silence of the Lambs was Buffalo Bill. He was named so, because he “skins his humps”. What he was doing was kidnapping heavier, young women. Then he kept them in an old cistern well in his basement, starving them ever so much, so their skin would be looser. During this process, he forced them to apply lotion to their skin, in order to keep it smooth, and soft.
Part of this process involved lowering the lotion in a small wicker basket to the victim. Bill never called these women by name, and in order to keep himself distanced mentally from the horrible things he was doing, he dehumanized the women. He never referred to them as people.
The actual lines from the movie are “It puts the lotion in the basket.” Not a command or even acknowledgement that there is a person down there. Almost a narration of events, to distance the killer from his victim. Another line is “It puts the lotion on its skin or it gets the hose again.” referencing the punishment for failure to comply. This form of, third person communication makes a horrifying event even creepier.