Cardinal Tarcisio Bertone, the Vatican's secretary of state, said the dialogue office would again become "a separate department", local media reported.
Vatican sources said Bertone's comments also meant the department would soon get its own leader again.
Benedict, after removing its president, Archbishop Michael Fitzgerald, had put the department under joint presidency with the Vatican's culture ministry.
Muslims saw the downgrading as a sign that the Vatican was not interested in engaging them.
In the Regensburg speech in September, the pope quoted a 14th century Byzantine emperor as saying Islam had only brought evil to the world and that it was spread by the sword, which was unreasonable and contrary to God's nature.
"Inter-religious dialogue is too important not to have experts advising the pope so that we don't have the kind of disaster that we had in Regensburg"
Tom Reese, Georgetown University
Although the pontiff said he regretted any misunderstanding it caused among Muslims, the speech continues to have repercussions on Catholic-Islam dialogue.
"I think it's a great idea," Father Tom Reese, senior fellow at Georgetown University's Woodstock Theological Centre and a world-renowned Vatican expert, said of the move to restore the inter-religious council.
"I just hope they get the right man [to head the department]," he said.
"In the 21st century, inter-religious dialogue is too important not to have experts advising the pope so that we don't have the kind of disaster that we had in Regensburg."
In France, home to Europe's largest Muslim minority, the priest in charge of relations with Islam said the change would help him in discussions and debates with Muslims.
"This is a sign, to Muslims and people of other faiths, that the policies of Pope John Paul will continue," Father Christophe Roucou said.