OTTAWA - Mounting governmental and household debt are posing new risks to the stability of financial systems, the Bank of Canada said Thursday in its most recent analysis.

The central bank's semi-annual "Financial System Review" finds that overall conditions have improved in the short term since it last reported in June.

But it adds that record-high debt by Canadian households pose an elevated medium-term risk if a second financial or economic shock were to materialize.

Bank of Canada governor Mark Carney has warned in the past about Canadians getting in over their heads with large mortgage commitments that don't appear problematic given today's low interest rates.

The bank repeats the warning in its systems review, stressing that rates aren't going to remain at historic lows forever and mortgage payments will rise.

This is both a potential problem for households and banks, the report states.

"When borrowing funds, especially in the form of mortgages, households need to assess their ability to service these debt obligations over their entire maturity, taking into account likely changes in both income and interest rates," the report stresses.

And the bank says lenders, such as the chartered banks, should be careful about extending mortgage loans even if they are insured.

That's because a borrower's default on mortgages would impact other loans.

The Bank of Canada notes that its review of potential risks is not intended as a prediction of what is likely to occur, but an early warning system of potential risks.

In this regard, one risk that is emerging is massive debt being taken on by governments throughout the world as they try to cope with the fall-out the deep recession.

The deteriorating fiscal positions leaves many governments vulnerable to future economic shocks, in that they are left with fewer resources.

The bank adds that the ability of governments to address current account imbalances - one of the believed root causes of the global downturn - would be hindered by the debt overload.

Although Canada remains in a fiscally strong position in relation to many other economies, with a debt-to-gross domestic product ratio projected to peak at about 35 per cent, it too would be impacted by the problems of others.

"Our financial system would be affected indirectly," the bank says, "since higher borrowing costs facing those countries with large financing needs would mute the global recovery."

"In addition, disorderly fluctuations in exchange rates could cause financial stress for Canadian businesses, financial institutions, and households."

The central bank says the outlook for the global economy has improved since June, but cautions that growth "is nonetheless likely to remain subdued for some time."

This makes global economies more vulnerable to any new shock that may emerge, the bank states.

Latest From ...