A pilot project will be launched soon, a source familiar with the Reserve Bank of India's (RBI) plan told Reuters, although the idea was met with some scepticism.
India has the world's third-largest current account deficit, which is approaching nearly $90 billion, driven in a large part by appetite for gold imports in the world's biggest consumer of the metal. That has played a major role in driving the rupee to a record low.
With 31,000 tonnes of commercially available gold in the country - worth $1.4 trillion at current prices - diverting even a fraction of that to refiners would sate domestic demand for the metal. India imported 860 tonnes of gold in 2012.
The RBI will ask the banks to buy back jewellery, bars and coins for rupees. Lenders will have to offer better rates than pawn shops and jewellers to lure sellers.
"We will start a pilot project among some banks where we will allow them to buy back gold from individual households," the source, an official familiar with the central bank's plan, said. "This will start soon, we have discussed (it) with banks."
The RBI did not immediately have an official comment, a spokeswoman said.
The RBI proposal was a talking point in world gold markets, although prices were reacting more to an easing of concerns that a U.S.-led attack on Syria was imminent. Spot gold prices fell by around 1 percent.
The source said banks in the pilot project would be given a regulatory directive to purchase the gold. It will initially be limited to those with big gold portfolios. Several Indian banks already offer a gold deposit scheme that pays out interest.
"I don't think it is going to work. It has to be more structured, like a gold bond," said Samiran Chakraborty, chief economist at Standard Chartered Bank.
That's exactly what India's Trade Minister Anand Sharma suggested on Thursday. He said the central bank should look into the possibility of monetising gold holdings, and issuing bonds for privately-held gold was one way to do it.
India's central bank holds 557.7 tonnes of gold in its own reserves.
However, any talk of using the central bank's gold to help meet India's international obligations revives memories of a 1991 balance of payments crisis - when India flew 67 tonnes of gold to Europe as collateral for a loan to avoid a sovereign debt default.
"I have not said there should be any mortgaging of the gold, or auction of the gold, that is incorrect. I have just said the RBI should look into ... how they can benefit the people, particularly with regard to the bonds or the monetisation," Sharma said in response to a question in parliament.
Earlier this week in comments reported in the national media, Sharma said that in a country with 31,000 tonnes of declared gold "even if 500 tonnes is monetised at today's value it takes care of your CAD", or current account deficit.
Selling the country's gold reserves may sit badly with Indians, many of whom saw the 1991 sale as a public humiliation. The secret operation was only exposed after a vehicle carrying the first consignment of bullion broke down on its way to the airport from the central bank.
"It (pledging gold) will be a desperate measure, and it will send a very wrong signal to the entire country because all the time we've maintained that things are under control even though things are adverse," said Madan Sabnavis, chief economist at CARE Ratings.
Such a sale would also dent international gold prices which took a hit earlier this year after Cyprus said it was considering selling its gold reserves to shore up its finances.
Some economists said India should improve the current gold deposit scheme, which allows individuals to effectively hold gold in a bank account in exchange for a certificate. They receive interest payments and can redeem the same weight in gold when the certificate matures.
Analysts say this scheme would also allow the government to funnel gold to the refinery industry and reduce import demand.
However, Indians are currently put off by the 500 gram minimum requirement. Offering higher interest rates could also draw out gold stashed in the country's temples. South India's Tirupati temple, considered one of the world's richest, is estimated to hold gold worth up to $80 billion.
Gold is considered auspicious as a gift or offering at religious festivals in India and forms an essential part of a bride's dowry.
"The biggest avenue the government has to monetise gold is the gold deposit scheme," said Shekhar Bhandari, executive vice president of treasury at Kotak Mahindra Bank. "It has the maximum potential and (encourages) recurring behaviour."
India has taken multiple steps this year to curb imports of gold, its second-biggest import after oil, including raising duty three times to 10 percent.
The rupee, the worst-performing emerging market currency in Asia this year, rebounded from a record low on Thursday after the RBI said it will provide dollars directly to state oil companies to shore up the currency.
In comments published by The Hindu newspaper last week, David Gornall, chairman of the London Bullion Market Association, said India could raise $23 billion by swapping gold for a payable currency for a period of its choice, while remaining the long-term holder of the gold.