"What about the practice of fractional reserve banking?
How come so many people (I'm not having a dig BTW this is a genuine question) who seem to understand other aspects of the economy much better than me don't realise the effect of this? Am I missing something?"
This is a touch confused because we've strayed out of Mortgages and into Deposit Taking. Basically a lender cannot lend money it doesn't have – if you are lending someone £100,000 you need to have £100,000 to give them, this money comes from deposits made in the form of savings.
Now savings can be withdrawn at any time – so fractional reserve banking is basically saying that if someone deposits £20,000 with you, you don't have to stick it all in a safe place until they need it. You can invest the majority (in the form of lending to others) as long as you keep a fraction in reserve in case they walk in and want to withdraw some – so if a bank has deposits of say £1bn they'll lend out 75% and keep 25% in reserve to cover withdrawals.
The problem can arise, which is called "a run on a bank" where so many people want to withdraw so much that the reserves can't cover the demand and the invested money can't be turned in to cash quick enough – which was the situation with Northern Rock.
Hope that helps…!?!