(Adds impact on bank results in paragraphs 3-8)
By Guillermo Parra-Bernal and Marcela Ayres
SAO PAULO/BRASILIA, June 23 (Reuters) - Loan delinquencies at Brazilian banks rose in May to the highest level in almost two years, the latest sign that companies and individuals are struggling to stay current on their debt as Latin America's largest economy sags.
The benchmark 90-day default ratio rose to the equivalent of 4.7 percent of outstanding loans in May, up from 4.6 percent in April, a central bank report showed on Tuesday. The indicator, which has risen for two straight months, was at the highest level since September 2013.
The uptick in defaults accompanied a surge in borrowing costs and banks' efforts to stem increasing loan-related losses, a situation that some analysts said could help prop up profitability. The data indicates that local lenders are becoming increasingly prudent as Latin America's largest economy heads this year for its steepest contraction since 1992.
"It's a rational response by the banking system to the dramatic deterioration of the macroeconomic picture in the past months," said Alberto Ramos, chief Latin America economist with Goldman Sachs Group Inc in New York.
Outstanding loans in Brazil's banking system rose 0.7 percent to 3.081 trillion reais ($994 billion) in May, the report showed. Lending rose 10.1 percent in the past 12 months, the slowest pace of expansion for credit since at least 2011, yet above the central bank's 9 percent estimate for this year.
Loan-loss provisions at private-sector banks rose to their highest level in at least 16 months in May as rising corporate defaults led them to tighten loan disbursement standards, the report said. State-controlled banks raised their own loan-loss provision ratios too.
In addition, the average interest rate for non-earmarked loans, the most widely followed gauge of credit in Brazil, climbed to 42.5 percent in May, the highest since the central bank began keeping records in 2011. Rising rates could help boost interest income in coming quarters, bolstering bank profits, said Philip Finch, a strategist with UBS Securities.
Borrowing costs in Brazil are the world's highest, reflecting the ability of banks to pass on to borrowers onerous litigation and repossession costs, high taxes and a surcharge for a history of high defaults.
Banking shares rose, underscoring confidence that prudent loan disbursement policies will cushion profits.
Shares in Itaú Unibanco Holding SA, Brazil's largest bank by market value, advanced 1.6 percent. State lender Banco do Brasil SA, the nation's largest by assets, jumped 2.1 percent.
$1 = 3.106 Brazilian reais Editing by Jonathan Oatis and Andrew Hay