India, which relies on oil imports from Iran, has been making payments to Hamburg's Europaeisch-Iranische Handelsbank, German business daily Handelsblatt reported this week.

The money flows through the Bundesbank, Germany's central bank, and is then wired by EIH to Iran. U.S. authorities have accused the EIH of funding Iranian weapons purchases but Berlin says there is no evidence that this is actually happening.

Spiegel Online, Germany's most-read news Web site, said the deal stands in direct connection to the release of two German journalists from an Iranian prison in February, after they had been detained as spies since last October. The German government acted as a mediator in the latest banking deal, the Web site says, citing an unnamed government source.

German Foreign Minister Guido Westerwelle in February flew to Iran to meet with Iranian President Mahmoud Ahmadinejad, in the first bilateral encounter between the Iranian president and a German foreign minister, to return the journalists to Germany after months of what Berlin has called "difficult negotiations."

The German opposition and exiled Iranians in Europe condemned the meeting as an unnecessary gesture to the Iranian regime but Westerwelle defended it as necessary to free the journalists.

The foreign minister has come under pressure from the German opposition and U.S. diplomats for the latest banking deal. It follows a decision by Germany to side with China and Russia to abstain in a U.N. Security Council vote regarding military action against Libya. While the move was widely seen as a nod to German voters ahead of two key regional elections, it did little to please the United States.

Washington is even less tolerant when it comes to helping Iran evade sanctions.

U.S. authorities have in the past accused the EIH of being a tool used by the regime in Tehran to circumvent sanctions on its biggest banks and of handling payments for Iranian missile and nuclear weapons development.

The recent transactions made via the German Federal Bank haven't gone down well in Washington; U.S. authorities want Berlin to block the payments.

"Treasury is concerned about recent reports that the German government authorized the use of EIH as a conduit for India's oil payments to Iran," a U.S. Treasury official who spoke on customary condition of anonymity told The New York Times. "Treasury will continue to engage with both German and Indian authorities about this situation, and will continue to work with all our allies to isolate EIH."

While U.S. banks are barred from doing business with EIH, the European Union hasn't listed the institution as involved in violating international sanctions. The bank has always denied any wrongdoing.

Germany says it closely monitors the bank's activities, with two observers permanently present at the bank to monitor and approve or block transactions valued more than $56,000.

Milan Peschke, a spokesman for the German foreign ministry earlier this week said that Berlin was "of course aware of the sensitivity of this problem."

However, with the EIH not on the EU's blacklist, "there is no legal basis to block its business activities," Peschke said.

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