But banks saw defaults rising on the credit when gold prices fell and values fell below the collateral.
Sri Lanka's private credit growth has slackened in 2013 after the end of a balance of payments crisis in 2011/2012 and loan growth became negative in February and March.
Many banks have sharply cut their gold backed loan portfolios in the first quarter. Sampath Bank, a private bank that has lent aggressively against gold saw a net contraction in their entire balance sheet as part of the correction process.
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"It will be self-funding operation, which will give a comfort to the banks, so that the appetite for gold backed lending will not diminish," he said.
"It will work on a premium will pay which will create the fund."
The Central Bank will contribute an initial 500 million rupees to the fund on behalf of the government.
Lenders are now give about 65 percent of the gold value as loans and the credit guarantee will allow them to loan about 15 percent more, he said.
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