The government has resolved a month-long payments dispute with Iran over oil shipments, a source at the oil ministry said on Thursday, by allowing a domestic bank to handle payments in euros with a Germany-based counterpart.

There is a backlog of around $2 billion in payments following the impasse, which started in December when the Reserve Bank of India (RBI) said the two sides could no longer use a long-standing clearing system run by regional central banks.

That move won praise from Washington, which said it would curb funds available for Iran's nuclear programme which it believes is aimed at building an atomic bomb.

The State Bank of India (SBI) will organise the payments, which will be in euros, with Iran-owned Frankfurt-based bank EIH, the source said on condition of anonymity.

SBI has got (assurance) from the highest levels of the government to deal with EIH. There is a backlog of around $2 billion in payments, the source said, adding SBI had been asked to start using the mechanism immediately.

The government will certify every transaction as a bona fide payment towards import of oil from Iran and vouch that the money is not being used by Tehran to boost its nuclear programme, the source said.

Iran is India's second biggest crude oil supplier, exporting about 400,000 barrels per day in trade worth roughly $12 billion a year to four refiners -- Mangalore Refinery and Petrochemicals Ltd, Essar Oil, Hindustan Petroleum, and Indian Oil Corp.