Should Canadian banks be worried about credit levels?

A global banking body has found that Canada ranks high in a key metric, which is a red flag for risk in its banking system

The Bank of International Settlements has tagged Canada as having one of the highest credit-to-GDP ratios in the developed world, cautioning that the “unusually” elevated level poses a risk to the country’s banking system.

Canada posted a gap reading of 12.1 in the first quarter, higher than the figure of 11.6 observed during the same period last year. Though it was far behind China’s staggering reading of 30.1, it is still among the most elevated observed among developed countries, and it was extreme enough for the BIS to single out Canada for having startlingly high credit growth compared to economic growth.

“Credit growth continues to be unusually high relative to GDP in several Asian economies as well as in Canada,” the BIS noted in its quarterly review.

The silver lining is that the latest credit-to-GDP measurement is better than the highs posted in 2015, when Canada’s gap reading reached 15.6 in the fourth quarter. With its data encompassing 43 countries worldwide, the BIS uses credit-to-GDP ratios as a possible portent of financial crises.

The finding of the BIS mirrors Statistics Canada’s recently reported reading of 167.6% for household credit market debt compared to disposable income in Q2 – a slight, but nevertheless concerning increase from the first quarter’s 165.2%.

Household debt has also surged as homebuyers take on progressively larger mortgages to keep up with skyrocketing housing prices – despite having stagnant incomes. Toronto and Vancouver have been identified by the Bank of Canada as two particularly hot markets, with the average single detached home selling for more than $1 million in both cities.

The BIS’s statement was softened by its clarification that the credit-to-GDP indicator is not an absolute predictor of future stress. However, the body did identify Canada as one nation at risk if interest rates were to move higher.

“Estimated debt service ratios, which attempt to capture principal and interest payments relative to income, appear to be at manageable levels at current interest rates for most countries, although they point to potential concerns in Brazil, Canada, China and Turkey,” the organization’s report said.

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