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OTTAWA (Reuters) - There is a slightly bigger risk of instability in the Canadian financial system than there was six months ago, with high household debt being the main domestic trouble, the Bank of Canada said on Wednesday.
In its twice-yearly Financial System Review, the bank once again raised concerns of over-borrowing by homeowners but it said the risk posed by that trend had not worsened since December.
"Even with an improved economic outlook, households cannot continue borrowing indefinitely at a rate that exceeds the growth of disposable income," the central bank said in the report.
It repeated comments from a June 15 speech by Bank of Canada Governor Mark Carney that "some moderation in the accumulation of household debt is expected."
The bank does see an increased risk, however, in the possible spillover effects from the European debt crisis as well as from excessive risk-taking in advanced economies by market players attracted by ultra-low interest rates.
"Sovereign risk and persistent weakness in the European banking sector could have spillover effects elsewhere, including Canada," it said.
Direct exposure of Canadian banks to peripheral European debt is minimal, but indirect exposure is more substantial through linkages to U.S. and European banks, the bank said.
But it's not only Europe that threatens Canada, according to the bank. The huge U.S. debt and Japan's fiscal standing are also on its radar.
"The unsustainable debt burdens of governments in several advanced economies continue to represent the principal threat to the stability of the Canadian financial system," it said.
Reporting by Louise Egan; editing by Rob Wilson