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The Canadian banks have outperformed expectations during the pandemic, but high debt levels pose a long-term threat, says Fitch Ratings.

In a new report, the rating agency noted that the banks have proven resilient over the past year, with strong liquidity and asset quality as substantial fiscal stimulus underpins the economy.

The Big Six banks reported strong earnings for their second quarter, beating analyst expectations.

“However, the rapid rise of private and public sector indebtedness is negative for long-term credit conditions and increases the sector’s vulnerability to financial stress,” the report said.

In April 2020, Fitch lowered the “operating environment” outlook for the banks to negative. That outlook will be reviewed in the third quarter, and if the score is downgraded, could pressure the banks’ credit ratings.

Fitch said that high debt levels, among both households and non-financial corporates, could result in a lower operating environment score.

The report estimated that private credit rose to 210.4% of GDP as of the end of 2020, up from an average 192.2% between 2015 and 2019.

“While debt service was made more manageable by ultra-loose monetary policy since March 2020, the share of private sector income dedicated to debt service has been on a long-term rising trend and on track to rapidly reach pre-pandemic levels,” it said.

At the same time, government debt levels have soared amid the provision of extensive fiscal stimulus.

Fitch estimates that Canada’s general government debt will rise to 122% of GDP in 2022, up from 86.3% in 2019.

“In conjunction with higher private-sector leverage, the public sector’s capacity to use fiscal policy as back-stop for the banking system during future crises has been diminished,” it noted.