How the UK Financial System Works
The UK financial system affects almost everyone.
For example, it allows people to:
- receive wages
- save money
- borrow money
- buy homes
- make payments
- invest
- take out insurance
- build pensions
However, the system involves much more than banks.
Instead, many different organisations work together. These include the government, regulators, banks, building societies, insurers and other financial firms.
Therefore, before looking at mortgages in detail, it helps to understand how the wider financial system works.
What Is a Financial System?
In simple terms, a financial system allows money to move between people, businesses and organisations.
For example, some people have money available to save.
Meanwhile, other people need to borrow.
Financial firms can help connect the two.
A simple example is:
Customer saves money
↓
Financial firm receives funds
↓
Money can help support lending
↓
Another customer borrows
Of course, the real financial system is much more complex.
However, the basic idea is simple:
The financial system helps money move to where it is needed.
Why Do We Need a Financial System?
Imagine there were no banks, building societies or other financial firms.
Someone wanting to buy a £250,000 home might need to save the whole £250,000 before buying it.
For most people, that would be extremely difficult.
Instead, the financial system allows people to borrow money.
As a result, a buyer may be able to provide a deposit and borrow the rest through a mortgage.
For example:
Home price: £250,000
Deposit: £50,000
Mortgage: £200,000
Therefore, mortgage lending is one part of the wider financial system.
Savers and Borrowers
One useful way to understand the financial system is to think about savers and borrowers.
Savers
Savers have money they do not currently need to spend.
Therefore, they may place it into:
- bank accounts
- building society accounts
- savings products
- investments
- pensions
Borrowers
Borrowers need access to money now and agree to repay it under agreed terms.
For example, they may borrow through:
- mortgages
- personal loans
- credit cards
- business loans
Therefore, the financial system helps connect people and organisations with different financial needs.
Financial Intermediaries
A financial intermediary acts between people or organisations with money and those who need money.
Banks and building societies are common examples.
For instance, a bank may receive deposits from customers.
Meanwhile, it may also provide loans and mortgages to other customers.
Therefore, the bank helps move money through the financial system.
This process is known as financial intermediation.
Remember
Financial intermediary = an organisation that helps connect providers and users of money.
The Main Parts of the UK Financial System
The UK financial system contains many different organisations.
However, for CeMAP, it is useful to divide them into several broad groups.
These include:
Government and HM Treasury
↓
The Bank of England
↓
Financial regulators
↓
Financial firms
↓
Customers and businesses
Each group has a different role.
However, they are connected.
Let’s look at the basic picture.
The UK Government
The UK Government has a major influence on the economy and financial system.
For example, government decisions can affect:
- taxation
- public spending
- borrowing
- financial laws
- housing policy
- economic policy
Therefore, changes in government policy can affect both financial firms and their customers.
For mortgage advisers, these changes can also affect the housing and mortgage markets.
HM Treasury
HM Treasury is the government’s economic and finance ministry.
It has important responsibilities for areas such as:
- public finances
- taxation policy
- government spending
- financial services policy
- economic policy
Therefore, HM Treasury plays an important part in shaping the UK’s financial system.
However, it does not carry out every financial function itself.
Instead, other organisations have their own roles.
One of the most important is the Bank of England.
The Bank of England
The Bank of England is the UK’s central bank.
It has several major responsibilities within the financial system.
For example, its work includes areas connected with:
- monetary stability
- financial stability
- interest rates
- the banking system
- issuing banknotes
One of its best-known roles involves the Bank Rate, often called the Bank of England base rate.
Changes in Bank Rate can influence borrowing and saving costs across the economy.
As a result, it can also affect mortgage rates.
We will look at the Bank of England in much more detail on the next page.
Financial Regulation
Financial services can involve large amounts of money.
In addition, customers may not always fully understand complex financial products.
Therefore, financial services need rules and oversight.
This is where financial regulation becomes important.
Regulation can help:
- protect consumers
- set standards for firms
- support confidence in financial markets
- reduce financial crime
- support the stability of the financial system
However, different regulators have different responsibilities.
Two names are particularly important for CeMAP:
FCA
and
PRA
The Financial Conduct Authority
The Financial Conduct Authority, or FCA, regulates financial services firms and financial markets within its responsibilities.
For a future mortgage adviser, the FCA is especially important.
For example, FCA rules affect areas such as:
- mortgage advice
- how customers are treated
- information given to customers
- financial promotions
- complaints
- conduct within financial firms
Therefore, you will see the FCA repeatedly throughout CeMAP.
A simple way to remember its role is:
FCA → Focuses strongly on how financial firms conduct their business and treat customers.
We will explore the FCA properly on a later page.
The Prudential Regulation Authority
The Prudential Regulation Authority, or PRA, is part of the Bank of England.
Its role is different from that of the FCA.
Broadly, the PRA focuses on the safety and soundness of certain financial firms.
These include important firms such as:
- banks
- building societies
- insurers
- certain investment firms
Therefore, the PRA is concerned with whether firms manage their financial risks properly and remain safe and sound.
A simple way to begin separating the two is:
FCA → Conduct and customers
PRA → Safety and soundness of certain firms
However, their full roles are more detailed.
We will look at each regulator separately later.
Banks
Banks are an important part of the financial system.
They provide many services to individuals and businesses.
For example, banks may offer:
- current accounts
- savings accounts
- mortgages
- personal loans
- credit cards
- business banking
- payment services
Therefore, banks can act both as a home for savings and as a source of borrowing.
Some banks are also major mortgage lenders.
Building Societies
Building societies provide many services similar to banks.
For example, they may offer:
- savings accounts
- mortgages
- other financial products
However, building societies have a different ownership structure.
Generally, they are mutual organisations owned by their members rather than outside shareholders.
Therefore, customers who meet the membership conditions can also be members of the society.
Building societies have played an important role in UK mortgage lending.
Banks and Building Societies: What’s the Difference?
At first, banks and building societies may look very similar.
After all, both may offer savings accounts and mortgages.
However, their ownership can be different.
Bank
A bank may be owned by shareholders.
Building Society
A building society is a mutual organisation owned by its members.
Therefore, the key difference is not simply the products they provide.
Instead, ownership and organisational structure are important.
Other Mortgage Lenders
Not every mortgage lender is a high-street bank or building society.
Other lenders also operate within the mortgage market.
For example, some firms may focus on:
- specialist mortgages
- customers with unusual income
- buy-to-let
- borrowers with complex circumstances
- particular types of property
As a result, the mortgage market contains a wide range of lenders.
Later, we will look more closely at how mortgage lenders operate.
Insurance Companies
Insurance companies are another important part of the financial system.
They provide protection against certain financial risks.
For example, insurance can cover areas such as:
- homes
- possessions
- life
- illness
- income
- vehicles
Insurance can also be relevant to mortgage advice.
For instance, buildings insurance is normally important when a property is being bought with a mortgage.
In addition, borrowers may consider protection for events such as death, illness or loss of income.
Therefore, mortgages and insurance can sometimes be closely connected.
Pension Providers
Pension providers help people save for retirement.
Money may be built up over many years and then used to provide benefits later in life.
Although pensions may seem separate from mortgages, a customer’s retirement plans can sometimes affect mortgage advice.
For example, the proposed mortgage term could continue into retirement.
Therefore, an adviser may need to understand the customer’s expected future income.
This is another example of why mortgage advisers need wider financial knowledge.
Investment Firms
Investment firms help customers invest money.
For example, investments may include:
- shares
- bonds
- investment funds
Investments can rise or fall in value.
Therefore, they involve different risks from ordinary cash savings.
Mortgage advisers do not automatically provide investment advice simply because they hold a mortgage qualification.
However, CeMAP includes wider financial knowledge so that advisers understand the financial environment around their customers.
Financial Markets
You will also hear the term financial markets.
These are systems through which financial assets and funding are bought, sold or exchanged.
For example, markets exist for:
- shares
- bonds
- currencies
- short-term money
- other financial assets
These markets can affect the wider economy.
In turn, changes in the economy can affect interest rates and mortgage lending.
Therefore, mortgage advice does not operate separately from financial markets.
The Money Market
The money market deals mainly with short-term borrowing and lending between financial organisations and other large participants.
At first, this may seem far removed from someone buying a home.
However, lenders need funding to provide mortgages.
Therefore, changes in the cost and availability of funding can eventually affect mortgage products and rates offered to customers.
You do not need to understand every detail yet.
For now, remember:
The cost of money to lenders can affect the cost of mortgages to borrowers.
The Capital Market
The capital market helps organisations raise longer-term finance.
For example, this can involve:
- shares
- bonds
- other longer-term funding
Therefore, while money markets generally focus on shorter-term funding, capital markets are more closely linked with longer-term finance.
Again, we will return to these ideas when they become relevant.
How Interest Rates Connect the System
Interest rates are one of the most important links between the wider financial system and mortgages.
For example, imagine the Bank of England changes Bank Rate.
This can influence the wider cost of borrowing.
In turn, financial firms may change rates on products such as:
- mortgages
- loans
- savings accounts
However, mortgage rates do not always move by exactly the same amount as Bank Rate.
Other factors also matter, including funding costs, market expectations, risk and competition.
Therefore, the relationship is important but not always direct.
A Simple Example
Imagine Bank Rate rises.
As a result, borrowing across the economy may become more expensive.
A lender may then increase some mortgage rates.
Therefore, a customer looking for a mortgage could face higher borrowing costs.
For example:
Higher interest rate
↓
Higher mortgage payment
↓
More household income needed for the mortgage
↓
Possible effect on affordability
This shows how a decision within the wider financial system can eventually affect an individual household.
How Inflation Connects to the Financial System
Another important idea is inflation.
Inflation means that the general level of prices is rising over time.
For example, food, energy and other household costs may become more expensive.
As a result, households may have less spare income.
At the same time, inflation can influence decisions about interest rates.
Therefore, inflation can affect mortgage customers in more than one way.
For example:
Higher living costs
↓
Less spare household income
and potentially:
Inflation pressure
↓
Interest-rate decisions
↓
Changes in borrowing costs
We will explore inflation properly later in CeMAP 1.
Why Financial Stability Matters
A financial system needs to be able to cope with problems.
For example, banks lend large amounts of money and hold customers’ deposits.
Therefore, serious problems within major financial firms could affect many people and businesses.
For this reason, financial stability is important.
The Bank of England and financial regulators have roles in helping maintain a stable financial system.
As a result, firms may be required to manage risks and hold appropriate financial resources.
Consumer Protection
The financial system also needs to work fairly for customers.
For example, consumers should receive appropriate information about financial products.
In addition, firms need to follow rules when carrying out regulated activities.
Therefore, consumer protection forms an important part of financial regulation.
Several organisations contribute to this system.
For example:
FCA → Regulates conduct within its responsibilities
Financial Ombudsman Service → Helps resolve eligible complaints
Financial Services Compensation Scheme → Can provide protection in certain cases when authorised firms fail
We will look at each of these separately later.
How Does This Connect to Mortgage Advice?
At first, the UK financial system may seem like a very large subject.
However, the links to mortgages become clearer when we put the pieces together.
For example:
Government economic policy
↓
Bank of England and financial conditions
↓
Financial markets and lender funding
↓
Banks and other mortgage lenders
↓
Mortgage products
↓
Mortgage advisers
↓
Customers
Therefore, the mortgage offered to a customer sits at the end of a much larger financial chain.
Understanding that chain helps explain why mortgage rates and lending conditions can change.
A Mortgage Adviser Sits Between the Customer and the Market
A mortgage adviser does not control interest rates or lender policies.
Instead, the adviser works within the financial system as it exists.
Therefore, they need to understand:
- the customer’s needs
- mortgage products
- lender requirements
- financial regulation
- economic conditions
- relevant risks
They then use this knowledge to help the customer make an informed mortgage decision.
As a result, wider financial knowledge has a practical purpose.
The Big Picture
The UK financial system contains many organisations.
However, you do not need to learn everything at once.
For now, think of the system like this:
UK Government and HM Treasury
Help shape economic and financial policy.
↓
Bank of England
The UK’s central bank, with important roles in monetary and financial stability.
↓
FCA and PRA
Regulate different parts of the financial system.
↓
Banks, building societies and other financial firms
Provide financial products and services.
↓
Mortgage advisers
Help customers understand and choose suitable mortgage solutions.
↓
Customers
Use financial products to meet their needs.
Each part has a different role.
However, they all form part of the same financial system.
Key Terms to Remember
Financial System
The network of organisations, markets and arrangements that allows money and financial services to move around the economy.
Financial Intermediary
An organisation that helps connect people or organisations with funds to those needing funds.
Bank of England
The UK’s central bank.
FCA
Financial Conduct Authority.
PRA
Prudential Regulation Authority.
Bank
A financial firm that may provide services such as accounts, savings, lending and mortgages.
Building Society
A mutual financial organisation owned by its members.
Financial Market
A system through which financial assets or funding can be bought, sold or exchanged.
Financial Stability
A situation in which the financial system can continue to function and cope with problems.
Quick Knowledge Check
Before moving on, let’s check what you have learned.
1. What is one of the main purposes of the financial system?
To help money move between people, businesses and organisations that have different financial needs.
2. What is a financial intermediary?
An organisation that helps connect providers and users of money.
3. What is the Bank of England?
The UK’s central bank.
4. What does FCA stand for?
Financial Conduct Authority.
5. What does PRA stand for?
Prudential Regulation Authority.
6. What is an important difference between a bank and a building society?
A building society is a mutual organisation owned by its members, while a bank may be owned by shareholders.
7. Can changes in the wider financial system affect mortgages?
Yes. For example, changes in interest rates and lender funding costs can affect mortgage rates and borrowing costs.
8. Why does a mortgage adviser need wider financial knowledge?
Because mortgage advice takes place within the wider financial system, and changes in regulation, the economy and financial markets can affect lenders and customers.
Quick Summary
To sum up, the UK financial system allows money and financial services to move through the economy.
First, the government and HM Treasury help shape economic and financial policy.
Meanwhile, the Bank of England has important responsibilities for monetary and financial stability.
In addition, regulators such as the FCA and PRA oversee different parts of financial services.
Banks, building societies and other financial firms then provide products such as savings, loans, mortgages, insurance and pensions.
Finally, customers use these products to meet their financial needs.
Therefore, mortgage lending is not a separate system.
Instead, it forms one part of a much larger financial network.
Most importantly, remember this chain:
Economy → Financial system → Lenders → Mortgages → Customers
As we move through CeMAP 1, we will now examine the most important parts of this system in more detail.
Next Page
The Bank of England Explained