The share capital of Grade II, III and IV urban co-operative banks could be seriously eroded as member-shareholders are likely to seek refunds of their subscriptions after the Reserve Bank of India banned these banks from declaring dividends.

The central bank's fiat to non-Grade-I urban co-operative banks not to pay dividends will impact almost 80 per cent of the 2,000-odd such banks across the country.

"Only a minuscule proportion of urban co-operative banks in India, in Grade I, can declare dividends. With the majority in lower grades and precluded from declaring dividends, there will be a churn in the urban co-operative banking sector. Further, with no dividend on their investment, shareholders will demand refunds," said Vinayak Y Tarale, chief executive officer, The Maharashtra State Co-operative Banks' Association.

In Maharashtra not more than 70 of the 658 urban co-operative banks fall in Grade I.

An urban co-operative bank is classified as Grade I if it complies with capital adequacy norms in the latest year, its net non-performing assets are less than 10 per cent of net loans and advances as on March 31, it reported a net profit for the previous financial year, and if it has not defaulted in the maintaining the cash reserve or statutory liquidity ratio in the previous financial year.

"Urban co-operative banks have traditionally used the lure of dividends -- ranging from 10 per cent to 30 per cent -- to augment their capital base," Tarale said. "The RBI directive could force shareholders to withdraw their membership as they do not get any return by staying invested."

Another cooperative banker, under condition of anonymity, said shareholders were unhappy with the RBI move and might want to pull out.

Urban co-operative banks strengthen their financials either by ploughing back their profits into general reserves or by attracting share capital by offering handsome dividends. However, with the second channel blocked, bankers fear the capital adequacy of Grade II, III or IV urban co-operative banks might be affected by flight of capital.

The RBI's contention is that urban co-operative banks tend to distribute dividends higher than what could be considered prudent given their financials.