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Banking watchdog sees a huge red flag in Canada's economy

A lifeguard raises a double red flag August 21, 2017 in Myrtle Beach, South Carolina. Canada’s credit-to-GDP gap has been identified as a concern by an international banking watchdog. (Photo by Chip Somodevilla/Getty Images)

While household debt hit a record high last week, Canada’s debt picture doesn’t get much rosier when you zoom out, either.

A new quarterly report from the Bank for International Settlements (BIS) includes Canada on a shortlist of countries that are at a critical level when it comes to the gap between credit and gross domestic product.

Alongside China and Hong Kong, BIS writes that the credit-to-GDP gap is a an early warning indicator for stress on the banking system, which can lead to a financial crisis.

READ MORE: Rising Rates and Rising Debt Levels May Provide Headwinds for Canadians

Canada’s credit-to-GDP gap is 11.3. Anything over 10 is considered a potential early warning sign. BIS defines the credit-to-GDP gap as the difference between current credit-to-GDP ratios and recent trend levels.

“In most cases, the warning signal given by credit-to-GDP gaps coincided with property price gaps also above critical thresholds,” the BIS report says. It takes into account loans and fixed income securities, not just household debt levels as last week’s Statistics Canada report did.

Canada’s hot real estate market in certain regions of the country is likely a contributing factor to perceived risk to the financial market, something that has been flagged for years. With both Vancouver and Toronto showing signs of cooling, however, the perceived risk may soon see a correction, and close the credit-to-GDP gap to a less volatile level.