The finance ministry may introduce a proposal in Budget 2008-09 to allow urban cooperative banks to get tax deductions up to a specified limit for the amount they set aside as provisions for bad loans.

According to a North Block source, the Reserve Bank of India [Get Quote] has suggested that deductions for bad loan provisioning be allowed up to an amount not exceeding 10 per cent of urban cooperatve banks' average advances, based on a certain formula.

Commercial banks currently get a similar deduction for their rural branches.

The move, sources said, is being considered principally in the interests of financial inclusion. Urban cooperative banks serve the middle class, lower middle class and urban poor and the offset would encourage them to lend more to such people.

"Considering that they take a higher risk by lending to the poor, such an incentive may be extended to the urban cooperatives," sources said.

Regulatory norms are also much stiffer for urban cooperative banks than their commercial counterparts. Cooperatives are mandated to extend 60 per cent of advances to the priority sector compared with 40 per cent for commercial banks.

Similarly, urban cooperative banks have to direct 25 per cent of their priority sector lending towards weaker sections of society.

Sources said that given that urban cooperatives are not permitted to access the capital market to raising resources, there was a need to helping them improve cash flows. For funds, urban cooperative banks rely on members' contributions and profits ploughed back into business.

There are about 1,850 urban cooperative banks in India and the cooperative banking sector accounts for about 5 per cent of total deposits and advances of the banking system.

Urban cooperative banks manage deposits of around Rs 1,12,240 crore (Rs 1,122.4 billion) and have advances of Rs 70,300 crore (Rs 703 billion).