* State banks grow loans faster than private peers
* Annual lending growth quickens to 16.6 percent
* Stable defaults pose question over debt levels
By Guillermo Parra-Bernal and Tiago Pariz
SAO PAULO/BRASILIA, Nov 29 (Reuters) - Bank lending in Brazil rose in October at the fastest pace in four months, recovering from a dip the prior month, as state-controlled banks stepped up disbursements to help kick-start activity in Latin America's largest economy.
State lenders led by Banco do Brasil SA, state development bank BNDES and Caixa Econômica Federal SA increased credit to individuals, companies and home buyers by an average 2.6 percent in October - the fastest pace since July, the central bank said in a report on Thursday.
Outstanding loans in Brazil's banking system rose 1.4 percent to 2.27 trillion reais ($1.08 trillion) in October from the prior month, the report showed. On an annual basis, credit expanded 16.6 percent - slightly gaining some momentum after annual lending growth hit a three-year low in September.
Demand for credit has lagged behind, with one in six families overleveraged, forcing the government to implement a series of interest-rate and tax reductions and incentives to revive borrowing. But banks, especially those in the private sector, have turned more rigorous as defaults stubbornly remain near record levels.
For a third consecutive month, public banks increased their loan banks at rates close or above 2 percent, in stark contrast with local private-sector and foreign banks, which boosted credit by 0.2 percent and 0.7 percent in October, respectively.
President Dilma Rousseff has been pressuring private-sector lenders to cut rates and boost access to credit, with relative success. Since late April, Rousseff and other officials have complained lenders charge some of the world's highest rates.
Rousseff has ordered state banks to step up lending, cut rates and fees and create new products. The government has used Banco do Brasil, the nation's largest bank by assets, and Caixa, the country's largest mortgage lender, to reduce the cost of credit and boost access for businesses and consumers.
Three of Brazil's largest banks are state-owned in terms of assets, and 46 percent of lending is provided by state banks.
The average cost of borrowing in the banking system fell for an eighth month in a row in September, hitting 29.3 percent. The spread, or the difference between the rate at which banks lend money and that at which it pays for deposits, fell to an all-time-low of 22 percentage points.
"Credit conditions are easing at a gradual pace: credit is increasing at a moderate pace and lending rates continue to decline," said Alberto Ramos, senior Latin American economist with Goldman Sachs Group in New York. "The public banks continue to gain market share."
Total corporate credit grew 1.2 percent in October on a monthly basis. Credit to individuals expanded 1.6 percent in October, outpacing the 1 percent pace in September. On an annual basis, however, consumer credit has slowed sharply to a 17.3 percent rate of expansion from 19.2 percent in June.
Non-performing loans, defined as those overdue for 90 or more days, remained stable at 5.9 percent in October for a fourth month. Non-performing consumer loans were unchanged at 7.9 percent and those for the corporate segment rose to 4.1 percent from 4 percent in September.
A slight pick-up in defaults in some corporate segments such as short-term loans and an increase in consumer lending prevented non-performing loans from declining. Delinquencies between 15 days and 90 days fell slightly for both groups - a sign officials see as a prelude to lower defaults in the months ahead.
"We believe that before the end of the year, defaults will take a break, though gradually," Tulio Maciel, head of economic research at the central bank, told reporters in Brasilia on Thursday.
Household debt ratios in Brazil fell in September from the prior month, a further indication that record low borrowing costs and a resilient job market are strengthening family budgets across the country. Debt-servicing expenses dropped to an average 22 percent of household income in September from 22.2 percent in August, the central bank added.
Since the start of November through Nov. 19, the average spread was unchanged at 22.3 points, while the average cost of borrowing climbed slightly to 29.5 percent. Average daily disbursements are up 3.7 percent for November compared with October in the latest evidence that demand for lending is likely to pick up.