In March this year, finance minister P Chidambaram was in Baramati, the home turf of agriculture minister Sharad Pawar. Both the ministers fielded a volley of questions on budget announcements. One was whether the government would review its decision to bring cooperative banks under the income tax net. Mr Pawar replied, saying there was no justification to exempt profit making cooperative banks from paying income tax. Six months down the line, a clutch of cooperative banks paid the first installment of advance tax based on their expected profitability for this fiscal. Of the 2,284 cooperative banks, around 1, 682 banks are making profits. Simultaneously, however, these banks have been pro-active in pushing their case for an income-tax exemption with the PMO. The demand is bound to figure in their pre-budget wish list as well. The revenue department doesnt want to yield. It reportedly reckons that bringing cooperative banks under the tax net would improve their standards of governance and accountability. Besides, it will ensure that they adhere to the discipline of filing tax audit reports and income tax (IT) returns. On their part, representatives of cooperative banks contend that tax audit reports are being filed along with IT for a number of years. Of course, there was no tax liability as these banks could claim a full deduction on their profits. There is really no question of violating tax laws, says Maharashtra Urban Cooperative Banks Federation chairman Mukund Ghaisas. However, there are no two views that UCBs need better regulatory supervision to improve governance standards and accountability. Over the years, there has been an erosion in public confidence in these banks after the spate of failures, particularly in the Western region. An easy solution may be hard to come by given the complex structure of the cooperative banking system. The problem is compounded by the fact that boards of many of these banks enjoy political patronage. Some state governments are now jointly working with the RBI to improve the financial health of these banks and this is seen to be yielding results. Business operations of UCBs grew at a moderate rate during fiscal 06, though scheduled UCBs grew at a relatively higher rate. RBI. The asset quality has also improved significantly. Coupled with this is the increase in profits of scheduled UCBs. According to RBI, the net profit of these banks rose to Rs 335 crore during fiscal 06 against Rs 137 crore in fiscal 05, marking a 144% increase. The improvement in performance may bolster the revenue departments case to rule out an income-tax exemption. However, even strong UCBs are finding it tough to attract equity funds as they have limited avenues for raising resources. A working group set up by the RBI to examine the issue of share capital to UCBs has identified alternate instruments to augment the capital funds of these banks. A feedback has been sought on the recommendations of the group chaired by RBI chief general manager N S Viswanathan. One of the most significant recommendations is to defer the imposition of income-tax on UCBs. The group is of the view that the RBI can make a suggestion to the government to defer the application of income-tax for at least three years. The rationale being that it would take a while for UCBs to raise alternate resources. Right now, retained earnings are the only source of owned funds for these banks. The suggestion to waive I-T for three years comes with the caveat that there would be restrictions on these banks to declare dividends. This will ensure that savings are used to bolster the capital base of these banks. A large number of UCBs are, in fact, short of the prescribed regulatory capital. Out of 217 UCBs with deposits of over Rs 100 crore, 30 banks or 15% of the banks in the sample considered by the working group were undercapitalised. The government may have to take a considered view on providing a breather to cooperative banks on I-T payments.