How Banks, Building Societies and Other Financial Firms Work
So far, we have looked at the organisations that shape and regulate the UK financial system.
However, customers usually deal with financial firms rather than regulators.
For example, someone looking for a mortgage may deal with:
- a bank
- a building society
- a specialist mortgage lender
- a mortgage broker
- an insurance company
Therefore, it is important to understand what these organisations do.
Although they all operate within financial services, they do not all work in the same way.
So, let’s start with the organisations most people already know: banks.
What Is a Bank?
A bank is a financial organisation that can provide a range of services to individuals and businesses.
For example, a bank may offer:
- current accounts
- savings accounts
- mortgages
- personal loans
- credit cards
- business banking
- payment services
However, not every bank provides every service.
Some banks focus on particular areas.
Others, meanwhile, provide a very wide range of financial products.
Therefore, the word bank covers many different types of business.
Banks Connect Savers and Borrowers
One important role of banks is financial intermediation.
We introduced this idea earlier.
In simple terms, banks can help move money between people who have funds and people who need funds.
For example:
Customers deposit money
↓
Bank receives funding
↓
Bank provides lending
↓
Other customers borrow
This is a simplified picture.
In reality, banks can obtain funding from several sources.
However, the basic idea helps explain why banks are important to the economy.
Banks Do More Than Lend Deposits
It would be too simple to say:
Banks take one customer’s savings and give exactly that money to another customer as a mortgage.
Modern banking does not work quite like that.
Banks create deposits when they make loans. Meanwhile, they also need to manage their overall funding, capital and liquidity.
Therefore, lending is part of a much larger financial process.
For CeMAP, the important point is this:
Banks bring together deposits, funding, capital and lending within a regulated financial system.
As a result, they can provide large amounts of credit to households and businesses.
How Does a Bank Make Money?
Banks can earn income in several ways.
For example, they may receive:
- interest from lending
- account charges
- product fees
- service fees
- other financial income
A simple example involves interest.
Imagine a bank pays interest on some savings while charging a higher rate on some lending.
The difference can contribute towards the bank’s income.
However, that difference is not pure profit.
The bank also has costs.
For example, it must pay for:
- staff
- technology
- branches
- regulation
- administration
- funding
- bad debts
- financial risk
Therefore, banking profitability is more complicated than simply comparing two interest rates.
Banks and Mortgages
Banks are major providers of mortgages in the UK.
For example, a bank may offer:
- first-time buyer mortgages
- home-mover mortgages
- remortgages
- fixed-rate mortgages
- variable-rate mortgages
- buy-to-let mortgages
However, lenders do not all offer the same products.
In addition, they do not all accept the same customers.
Therefore, one bank may accept a mortgage application that another bank would decline.
This is because lenders have different lending criteria.
What Are Lending Criteria?
Lending criteria are the rules a lender uses when deciding which applications it may accept.
For example, criteria may cover:
- income
- employment
- affordability
- credit history
- age
- loan-to-value
- property type
- mortgage term
- source of deposit
Therefore, having enough income does not automatically mean a customer will qualify for every mortgage.
Instead, the customer must also meet the lender’s relevant criteria.
This is one reason mortgage advisers need to understand different lenders.
A Simple Lending Example
Imagine two customers both earn:
£40,000 a year
At first, they may appear to be in the same position.
However, Customer A has:
- no loans
- no credit-card debt
- a large deposit
Meanwhile, Customer B has:
- a large personal loan
- significant credit-card balances
- a smaller deposit
Therefore, their mortgage options could be very different.
So, lenders look at the wider financial picture rather than salary alone.
What Is a Building Society?
A building society provides many services that can look similar to those provided by a bank.
For example, a building society may offer:
- savings accounts
- mortgages
- other financial products
However, there is an important difference.
A building society is a mutual organisation.
Therefore, it is owned by its members rather than external shareholders.
What Is a Mutual Organisation?
A mutual is an organisation owned for the benefit of its members.
For a building society, eligible savers and borrowers may become members.
Therefore:
Bank
May be owned by shareholders.
Meanwhile:
Building society
Is owned by its members.
This is one of the main differences to remember.
Why Are They Called Building Societies?
Building societies developed from groups of people who came together to help members save and finance homes.
Over time, they developed into major financial organisations.
Today, building societies can provide services to very large numbers of customers.
However, their mutual ownership structure remains an important feature.
In addition, mortgage lending continues to be a major part of the building society sector.
Banks Versus Building Societies
Let’s compare them.
| Bank | Building Society |
|---|---|
| May be owned by shareholders | Owned by members |
| Can provide mortgages | Can provide mortgages |
| Can offer savings | Can offer savings |
| May offer many other financial services | Often has a strong savings and mortgage focus |
| Operates for its owners | Operates as a mutual for members |
Therefore, both can be mortgage lenders.
However, their ownership structures are different.
What Is a Mortgage Lender?
A mortgage lender is an organisation that provides mortgage finance.
Many mortgage lenders are:
- banks
- building societies
However, not all mortgage lenders fit neatly into those two groups.
For example, the market also includes specialist lenders.
Therefore, a customer may have more options than the familiar high-street names.
What Is a Specialist Mortgage Lender?
A specialist lender focuses on parts of the mortgage market that may require a different lending approach.
For example, some specialist lenders may consider customers with:
- complex income
- self-employment
- unusual property types
- previous credit problems
- buy-to-let needs
- circumstances outside mainstream lending criteria
However, this does not mean every specialist lender accepts every unusual application.
Each lender still has its own criteria.
Therefore:
Specialist does not mean automatic acceptance.
Instead, it means the lender may focus on particular types of mortgage business.
Mainstream and Specialist Lending
A useful distinction is:
Mainstream Lender
Often serves a broad range of typical mortgage customers.
Meanwhile:
Specialist Lender
May focus more strongly on customers or properties with particular circumstances.
For example, someone with straightforward employment, good credit and a standard property may have many mainstream options.
However, someone with complex income may need a lender that takes a different approach to assessing that income.
Therefore, different lenders can serve different parts of the market.
Why Do Lenders Have Different Rules?
Mortgage lending involves risk.
Therefore, each lender decides what types of lending fit its business model and risk approach.
For example, one lender may be comfortable lending on certain property types.
Another may not.
Similarly, one lender may accept a particular form of income.
Another may apply stricter conditions.
Therefore:
Same customer
Different lender
=
Potentially different decision
This is extremely important in mortgage advice.
What Is a Mortgage Broker?
A mortgage broker is different from a mortgage lender.
The broker does not normally provide the mortgage money.
Instead, a broker helps customers find and arrange mortgages from lenders within the scope of the service offered.
Therefore:
Lender → Provides the mortgage
Broker → Helps arrange the mortgage
This is a key difference.
What Does a Mortgage Adviser Do?
A mortgage adviser helps a customer understand their mortgage needs and, where advice is being provided, recommends an appropriate mortgage in line with the relevant requirements.
For example, the adviser may consider:
- income
- spending
- debts
- deposit
- property
- future plans
- mortgage preferences
- affordability
- relevant risks
The adviser can then consider appropriate mortgage options.
Therefore, mortgage advice involves much more than finding the lowest advertised rate.
Broker Versus Adviser
You will often hear the words broker and adviser used together.
However, they describe slightly different ideas.
A broker generally acts as an intermediary between customers and mortgage lenders.
Meanwhile, an adviser provides mortgage advice.
In practice, the same person or firm may do both.
Therefore, someone may commonly be described as a:
Mortgage broker
or:
Mortgage adviser
The exact regulatory activities being carried out are what matter.
What Does Whole of Market Mean?
You may hear the phrase whole of market when discussing mortgage brokers.
However, it is important to understand exactly what service a firm actually offers rather than relying on a label alone.
Different firms may consider different ranges of lenders and products.
For example, a firm’s service could be based on:
- products from one lender
- a limited panel of lenders
- a broad range across the market
Therefore, customers should be told the nature and scope of the service being provided.
We will study mortgage disclosure requirements later.
Tied and Limited Services
Some mortgage advisers may work with a restricted range of mortgage products or providers.
For example, an adviser working for a particular lender may advise only on that lender’s mortgages.
Meanwhile, another firm may use a panel of lenders.
Therefore, two advisers may have access to different products.
This matters because the customer should understand the scope of the service.
Direct Mortgage Applications
Not every customer uses a mortgage broker.
Some apply directly to a lender.
For example:
Customer
↓
Bank or building society
↓
Mortgage application
This is known as going direct to the lender.
Meanwhile, another customer may use an intermediary:
Customer
↓
Mortgage broker
↓
Lender
Both routes exist within the mortgage market.
Advice and Execution-Only
There is also an important difference between receiving mortgage advice and completing a mortgage transaction without advice in circumstances where execution-only is permitted.
Advice
A regulated recommendation is made based on the customer’s circumstances and needs.
Meanwhile:
Execution-Only
The customer makes their own decision without receiving a personal recommendation.
However, execution-only mortgage business is subject to regulatory rules and is not simply a way to avoid the advice requirements.
Therefore, we will study this area carefully later.
Insurance Companies
Insurance companies are another major part of financial services.
They provide financial protection against certain risks.
For example, insurance can include:
- buildings insurance
- contents insurance
- life insurance
- income protection
- critical illness cover
- motor insurance
Some of these can become relevant during the mortgage process.
Therefore, mortgage advisers need a basic understanding of insurance even if their role is focused mainly on mortgages.
Why Is Insurance Relevant to Mortgages?
Buying a home creates financial risks.
For example, imagine a house is seriously damaged by fire.
Without suitable buildings insurance, the financial consequences could be enormous.
Therefore, mortgage lenders normally require appropriate buildings insurance to be in place according to their mortgage conditions.
Meanwhile, borrowers may also consider personal protection.
For example, they may consider what would happen to the mortgage if they:
- died
- became seriously ill
- lost income
Therefore, mortgage planning can connect with wider protection needs.
Investment Firms
Investment firms help individuals and organisations invest money.
For example, investments may include:
- shares
- bonds
- investment funds
However, investments can rise and fall in value.
Therefore, they involve risks that are different from ordinary cash savings.
A CeMAP qualification does not automatically allow someone to provide regulated investment advice.
Nevertheless, CeMAP includes wider financial knowledge because mortgage customers may also have investments and other financial arrangements.
Pension Providers
Pension providers help customers save and invest for retirement.
At first, pensions may appear separate from mortgage advice.
However, the two can sometimes connect.
For example, imagine a customer is aged 55 and wants a 25-year mortgage.
The mortgage would continue until age:
80
Therefore, the lender and adviser may need to consider the customer’s expected income during retirement.
As a result, pensions can become relevant to mortgage affordability and planning.
Credit Unions
A credit union is a member-owned financial co-operative.
Credit unions can provide services such as:
- savings
- loans
- other financial services
They generally serve people who meet the credit union’s membership requirements.
Therefore, like building societies, credit unions operate on a mutual basis.
However, they have their own structure and regulatory framework.
Finance Companies
Some financial firms specialise in providing credit rather than traditional banking services.
For example, finance companies may provide:
- personal finance
- vehicle finance
- consumer credit
- business finance
Therefore, the financial system includes many lenders beyond banks.
This matters to mortgage advice because existing credit commitments can affect a customer’s affordability.
For example, a car-finance payment could reduce the amount of income available for mortgage payments.
Existing Debt Matters
Imagine a customer earns:
£50,000 a year
However, they also pay:
£500 per month for a loan
and:
£350 per month for car finance
Therefore, £850 of their monthly income is already committed before considering the mortgage.
As a result, lenders may take these commitments into account when assessing affordability.
So, understanding other forms of credit is also important for mortgage advice.
What Are Financial Intermediaries?
We introduced financial intermediation earlier.
Now, we can see several examples.
For instance:
Banks
Connect funding and lending.
Building societies
Connect member savings and lending.
Mortgage brokers
Connect customers with mortgage lenders.
Investment intermediaries
Can connect investors with investment products and markets.
Therefore, intermediaries help different parts of the financial system interact.
How Are Financial Firms Regulated?
Different financial firms can be regulated in different ways.
For example, depending on their activities, a firm may be regulated by:
- the FCA
- the PRA
- both the FCA and PRA
A major bank, for instance, may be subject to both.
The PRA may focus on its financial safety and soundness.
Meanwhile, the FCA may focus on conduct, markets and customer treatment.
Therefore, regulation depends partly on what the firm does.
What Happens When a Bank Fails?
Banks are regulated carefully.
However, regulation cannot guarantee that a bank will never fail.
Therefore, the financial system also contains protections and procedures for dealing with failure.
For example, eligible deposits may receive protection through the Financial Services Compensation Scheme (FSCS), subject to the scheme’s rules and limits.
Meanwhile, the Bank of England has responsibilities for resolving certain failing financial institutions.
Therefore, the system aims both to:
Reduce the risk of failure
and
Limit harm if failure occurs
Financial Services Compensation Scheme
The Financial Services Compensation Scheme, usually shortened to FSCS, can protect eligible customers when certain authorised financial firms are unable to meet claims against them.
For example, eligible deposits may be protected up to the applicable limit.
However, different limits and rules can apply to different types of financial product.
Therefore, never assume that all money or every financial loss is automatically protected.
We will study the FSCS separately later.
How Does a Mortgage Move Through the System?
Let’s now put several organisations together.
Imagine Alex wants to buy a home.
First:
Alex wants a mortgage
↓
Alex speaks with a:
Mortgage adviser
↓
The adviser considers:
Alex’s needs and circumstances
↓
The adviser researches appropriate:
Mortgage lenders and products
↓
Alex applies to a:
Bank, building society or other lender
↓
The lender carries out:
Underwriting and affordability checks
↓
If approved:
Mortgage offer
↓
Finally:
Funds are provided for the property purchase
This simple chain shows how different parts of financial services connect.
Where Does Regulation Fit In?
Regulation surrounds the whole process.
For example:
PRA
May regulate the lender’s prudential safety and soundness.
Meanwhile:
FCA
Regulates relevant conduct, mortgage lending and advice activities.
In addition:
MCOB
Provides important FCA mortgage and home-finance rules.
Therefore, regulation does not sit outside mortgage lending.
Instead, it forms part of the framework in which lenders and advisers operate.
Why Does Competition Matter?
There are many mortgage lenders in the UK.
Therefore, lenders compete for business.
Competition can affect:
- interest rates
- fees
- mortgage features
- service
- lending criteria
- product design
For example, one lender may offer a lower rate but charge a larger fee.
Meanwhile, another may offer a higher rate with no product fee.
Therefore, the cheapest-looking mortgage is not automatically the best option.
The customer’s circumstances matter.
Why Doesn’t Everyone Use the Same Lender?
If one lender offered the lowest mortgage rate, you might wonder why every customer would not simply use that lender.
However, mortgage lending does not work like that.
The customer may not meet that lender’s criteria.
Alternatively, the product may not suit the customer’s circumstances.
For example, differences could involve:
- income type
- LTV
- property
- credit history
- mortgage term
- fees
- early repayment charges
- flexibility
Therefore:
Lowest rate does not automatically mean most suitable mortgage.
This is one of the most important ideas in mortgage advice.
Lender Risk and Customer Needs
A mortgage involves two different viewpoints.
The Customer Asks:
Does this mortgage meet my needs?
Meanwhile:
The Lender Asks:
Are we willing to lend in these circumstances?
Both questions must lead to an acceptable outcome for the mortgage to proceed.
Therefore:
Customer suitability
Lender criteria
=
Possible mortgage solution
This is a useful way to understand the mortgage market.
Key Terms to Remember
Bank
A financial organisation that can provide services such as accounts, savings and lending.
Building Society
A mutual financial organisation owned by its members.
Mutual
An organisation owned for the benefit of its members.
Mortgage Lender
An organisation that provides mortgage finance.
Specialist Lender
A lender focusing on particular customer, property or mortgage circumstances.
Lending Criteria
The lender’s rules for deciding which mortgage applications it may accept.
Mortgage Broker
An intermediary that helps customers find and arrange mortgages within the scope of its service.
Mortgage Adviser
A person who provides regulated mortgage advice where authorised to do so.
Credit Union
A member-owned financial co-operative.
Financial Intermediary
An organisation that helps connect different users and providers of financial services or funds.
Quick Knowledge Check
Before moving on, let’s check what you have learned.
1. What is one important role of a bank?
To provide financial services such as deposits, payments and lending.
2. What is the main ownership difference between a bank and a building society?
A building society is owned by its members, while a bank may be owned by shareholders.
3. What are lending criteria?
The rules a lender uses to decide which mortgage applications it may accept.
4. What is a specialist lender?
A lender that focuses on particular types of customers, properties or mortgage circumstances.
5. Does a mortgage broker normally provide the mortgage money?
No. The mortgage lender provides the mortgage, while the broker acts as an intermediary.
6. Why might two lenders make different decisions about the same customer?
Because lenders can have different criteria, risk approaches and business models.
7. Is the mortgage with the lowest interest rate always the most suitable?
No. Fees, conditions, features, eligibility and the customer’s circumstances also matter.
8. Why can pensions become relevant to mortgage advice?
Because a mortgage may continue into retirement, so future retirement income can become important.
9. Why can other debts affect a mortgage application?
Because existing payments reduce the income available for mortgage and household costs.
10. Can a large bank be regulated by both the FCA and PRA?
Yes. The regulators have different responsibilities.
Quick Summary
To sum up, many different financial firms operate within the UK financial system.
Banks provide services such as deposits, payments and lending.
Meanwhile, building societies provide many similar services but operate as mutual organisations owned by their members.
In addition, specialist lenders serve particular parts of the mortgage market.
Mortgage brokers and advisers, meanwhile, help connect customers with appropriate mortgage options within the scope of their services.
Other organisations, including insurers, pension providers, credit unions and finance companies, also form part of the wider financial system.
Therefore, the mortgage market can be pictured like this:
Customers
↓
Mortgage advisers and brokers
↓
Banks, building societies and specialist lenders
↓
Mortgage products
However, the entire system operates within a regulatory framework.
So, remember:
Lender → Provides the money
Broker → Connects customer and lender
Adviser → Provides mortgage advice
Most importantly, lenders have different criteria.
Therefore, the same customer may receive different decisions from different lenders.
This leads to one of the most important principles in mortgage advice:
The lowest rate is not automatically the most suitable mortgage.
Instead, the customer’s needs, costs, circumstances, lender criteria and mortgage features all need to be considered together.
Next Page
Savings, Investments and Borrowing Explained