"The inmates have vowed to fight us with grenades... We are repeatedly asking them to give up," Dhaka's police commissioner Asaduzzaman Mian told reportersn at the scene at Ashkona area of the capital.
He said two women already came out from the three-storey building with their children.
Police said three militants believed to be operatives of neo-Jamaatun Mujahideen Bangladesh (neo-JMB) were inside the building.
The outfit, said to be inclined to the Islamic State, was behind the July 1 terror attack on a Dhaka cafe in which 22 people, including 17 foreigners, were killed.
The commissioner has said police wants to capture the militants alive without using force "as any miscalculation could appear deadly in this densely populated neighbourhood".
Another official at the scene said one of the two women who surrendered was the wife of a slain renegade ex-army major who was killed on September 2 this year in a police encounter during a nearly identical raid at Dhaka's Mirpur area. The other woman was the wife of a neo-JMB leader.
Ambulances and fire fighting units were kept stand-by outside the building while elite anti-crime Rapid Action Battalion (RAB) and plainclothesmen cordoned off the area.
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