Parents and other relatives of a person barely notice their shortcomings and faults. For example, some parents go as far as defending their notorious children even if the evidence points to the fact that they are responsible for certain misdeeds. Noticing this, our ancestors came up with this problem that encourages people to accept their loved ones as they are. For example, every parent believes their children are largely faultless and is quick to blame the child's friend regardless of the contrary evidence.
The proverb encourages people to accept their loved ones as they are no matter how the world sees them. There are some people who are easily dissuaded by how other people perceive their loved ones to the extent that they change their attitude towards their loved ones. The proverb is also used to observe a situation where one sees no faults in someone dear to them.