HookThe first bank run in 140 years
On 14 September 2007, queues formed outside Northern Rock branches from Newcastle to Kingston as savers demanded their money back. It was the first run on a British bank in about 140 years. Northern Rock was not fraudulent and, on paper, not insolvent — it was doing exactly what banks do, borrowing short to lend long. But it had funded a mortgage book stretching decades ahead by borrowing in the wholesale money markets for months at a time, and when those markets froze in the credit crunch, the funding vanished overnight. The Bank of England stepped in as lender of last resort; within months the bank was nationalised.
Every idea in this section lives inside that story: the money markets Northern Rock depended on, the maturity transformation that made it fragile, the central bank that rescued it, and the regulatory system that failed to see it coming. This section explains what financial markets are for, how banks create the money you spend, how the Bank of England steers the whole economy from one interest rate, and why we regulate all of it so heavily.
ModelThe structure of financial markets and financial assets
Financial markets exist to channel funds from savers to borrowers, to provide liquidity, and to price and spread risk. AQA splits them by maturity and function. Money markets handle short-term borrowing and lending — under a year — through instruments such as interbank loans, Treasury bills and commercial paper; this is the market Northern Rock leaned on. Capital markets handle long-term finance: the bond market, where governments and firms borrow by issuing debt, and the equity market, where companies raise permanent finance by selling shares. Foreign exchange markets trade currencies.
The distinction that trips students is debt versus equity. A bond is a loan — a fixed promise to repay with interest, ranking ahead of shareholders if the firm fails. A share is ownership — a claim on profits through dividends, riskier but with unlimited upside. The single most examined mechanic here is the inverse relationship between bond prices and yields: because a bond's coupon is fixed in cash, a fall in its market price raises the effective return the buyer earns, and a rise in price lowers it. When markets 'sell off gilts', yields — the government's cost of borrowing — go up.
Take a government gilt with a face value of £100 paying a fixed £5 coupon each year, so its yield at issue is 5 ÷ 100 = 5%. Suppose fears about inflation make investors dump gilts and the market price falls to £80. The coupon is still £5 in cash, so the yield a new buyer earns is 5 ÷ 80 = 6.25%. The price fell and the yield rose — the inverse relationship in one calculation. This is exactly the mechanism behind the phrase 'rising gilt yields': the price of existing government debt is being pushed down, and the state's cost of new borrowing is being pushed up.
MechanismCommercial banks and investment banks
A commercial bank — Lloyds, Barclays, NatWest — takes deposits and makes loans. Its core trick is maturity transformation: turning deposits that can be withdrawn on demand into mortgages and business loans that last for years. That is genuinely useful, and inherently fragile, because if too many depositors want their money at once, no bank can pay — the vulnerability Northern Rock exposed. A bank's balance sheet makes the trade-off visible: liabilities are mostly customer deposits (money the bank owes), while assets are loans, reserves and securities (money owed to the bank). Managing it means juggling three aims that pull against each other — liquidity (holding enough cash to meet withdrawals), profitability (lending long earns more but ties money up), and security (avoiding bad debts).
Banks also help create money. When a bank makes a loan it credits the borrower's account, and that new deposit is new money in circulation — credit creation. An investment bank does something different: underwriting share and bond issues, advising on mergers, and trading securities. After 2008, Britain forced the two apart: since January 2019, banks with large retail deposits must ring-fence everyday deposit-taking from riskier investment-banking activity, so that a trading loss cannot sink ordinary savers' accounts.
ModelCentral banks and monetary policy
The Bank of England has three jobs: keep prices stable, keep the financial system stable, and act as banker to the government and lender of last resort. Its headline tool is monetary policy, run by the nine-member Monetary Policy Committee, which meets eight times a year to set Bank Rate with a legal remit to hit 2% CPI inflation. The transmission mechanism is the chain AQA wants you to trace: a change in Bank Rate feeds into the interest rates banks charge and pay, which changes borrowing and saving, which changes consumption and investment, which shifts AD, which moves output and inflation. Raising rates in 2022–23 was meant to cool demand and, with it, inflation.
When rates near zero leave no room to cut, central banks reach for quantitative easing: creating reserves to buy government bonds, pushing bond prices up and yields down to loosen conditions across the economy. The Bank of England's QE programme grew to around £895bn of asset purchases by the end of 2021 before it began reversing — quantitative tightening — as inflation surged. Forward guidance, signalling the likely future path of rates, is a further lever: expectations move spending today, so what the Bank says can matter almost as much as what it does.
CaseThe regulation of the financial system
Finance is regulated more heavily than almost any other industry because its failures are contagious. One bank's collapse can trigger others through shared exposures — systemic risk — and the knowledge that the state may rescue a failing bank creates moral hazard, tempting banks to take risks they would otherwise avoid because losses may be socialised. Add the asymmetric information between banks and their customers, and finance is a textbook case for intervention.
The 2007–08 crisis rebuilt Britain's regulatory architecture. The old single regulator was replaced in 2013 by a split system: the Prudential Regulation Authority, inside the Bank of England, supervises the safety and soundness of individual banks and insurers; the Financial Conduct Authority polices market conduct and protects consumers; and the Financial Policy Committee watches for system-wide, macro-prudential threats. Internationally, the Basel III rules force banks to hold far more high-quality capital and liquidity than before 2008, so they can absorb losses without a taxpayer bailout. The tension examiners love is real: tighter capital rules make banks safer but can restrict lending and slow growth — regulation, like everything in this section, is a trade-off rather than a free lunch.
VocabularyKey terms the mark scheme pays for
TrapsMisconceptions that cost marks
ExamWhat examiners want
The examiner's favourite calculation here is the bond price–yield relationship: know that yield equals coupon divided by price, and be ready to explain in words why a sell-off in gilts raises the government's borrowing costs. State the mechanism, not just the direction.
Monetary-policy questions reward a fully traced transmission mechanism. Do not write 'higher rates reduce inflation' and stop — walk the chain: Bank Rate up, so commercial lending and mortgage rates up, so borrowing and consumption down and saving up, so AD shifts left, so demand-pull inflation eases. Every link you name is a mark, and the evaluation is in the time lags (up to around two years for the full effect) and the limits when confidence, not the cost of credit, is what is holding spending back.
On regulation and 'should banks be more tightly controlled' essays, build the answer on market failures — systemic risk, moral hazard, asymmetric information — then evaluate the cost: capital rules that make banks safer can also restrict lending and slow growth. Anchor every point in a real case (Northern Rock, the 2008 bailouts, QE reaching £895bn, ring-fencing from 2019) — AQA's top level descriptors demand exactly that specificity.