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The Bank of Canada's recent Financial System Review, which outlines risks to the country’s financial stability, found that the Canadian financial system was still resilient, helped along by a strengthening economy.Adrian Wyld/The Canadian Press

Canada can't quite shake off a key indicator of serious financial system stress.

In a new quarterly report from the Bank for International Settlements, Canada is among the few countries that triggers a warning about high levels of debt compared to longer-term averages. This sends up red flags about risks in the country's domestic banking systems.

BIS, a body made up of the world's central banks, puts a lot of stock in what it calls the "credit-to-GDP gap" as a signal of vulnerability. The gap is the difference between the credit-to-GDP ratio and its long-term trend in a particular country. The analysis looks beyond mere household debt figures to include other loans and fixed-income securities, and it is considered a harbinger of potential financial crises. China and Hong Kong are also noted to be at risk.

Frothy regional housing markets and high household debt levels have been nagging concerns for lenders and policy makers in many major Canadian markets for many years. At the federal level, successive Conservative and Liberal governments have made a number moves that tighten up mortgage rules to discourage home buyers from chasing ever-more-expensive houses with too much debt. Provincial governments in British Columbia and Ontario also put in new measures to try to curb housing speculation by foreign buyers.

Overheated housing markets are a common cause of a big credit-to-GDP gap. Canada's gap now stands at 11.3 percentage points above the long-term average, down from 14.1 percentage points in the previous quarterly reading. While this drop is encouraging, any result of more than 10 percentage points is considered cause for concern.

"In most cases, these large gaps coincided with property price gaps above critical thresholds," the report states. Canada is among the countries that have drawn BIS attention for its soaring property prices in other reports.

But Toronto's hot real estate sector has showed signs of mellowing of late. And the Bank of Canada's recent rate increases, which have doubled the policy interest rate from 0.5 per cent to 1 per cent, are expected to further weaken house prices that have been sliding in the Greater Toronto Area for several months, even as Canadian home prices have edged up over all.

The central bank's recent Financial System Review, which outlines risks to the country's financial stability, found that the Canadian financial system was still resilient, helped along by a strengthening economy.

Those conditions are buoying other global markets, and the BIS has noted an increase in investor risk-taking spurred by reduced concerns about monetary policy constrictions as well as the prolonged low-interest rate environment.

"Share prices continued to climb towards new peaks, volatility plunged to new depths, and credit spreads tightened to levels not seen since the Great Financial Crisis," said Claudio Borio, head of the monetary and economic department at the BIS, adding that it seemed as if a "Goldilocks economy" had arrived in the recent quarter.