Israel urged by Yellen to help Palestinian economy function

In a letter to Prime Minister Benjamin Netanyahu, Yellen and several of her global counterparts urged the Israeli leader’s government to approve a waiver that would continue to allow Palestinian and Israeli banks to correspond. Without the waiver, the Palestinian banks would be cut off from Israel’s financial system, severing a relationship that supports $13.2 billion in trade, according to the letter.

Israeli Finance Minister Bezalel Smotrich has until Oct. 31 to sign off on renewing the waiver, which must be done periodically. Failing to renew the banking relationship risks disrupting the disbursement of millions of dollars of international donor support, according to the letter, which was reviewed by The Wall Street Journal.

Smotrich, an ultranationalist hard-liner and settler leader, and his far-right allies oppose and have sought to weaken the U.S.-backed Palestinian Authority, which governs parts of the West Bank and cooperates on security issues with Israel. Spokespeople for Smotrich and the Israeli prime minister’s office didn’t immediately respond to requests for comment.

“We write to emphasize our fear that actions taken by some members of your government to deny the West Bank access to financial resources endangers Israel’s security and threatens to further destabilize the entire region in an already perilous moment," the letter said.

The Palestine Monetary Authority, which effectively serves as the central bank for the West Bank and Gaza, didn’t immediately respond to a request for comment. The U.S. Treasury Department declined to comment.

Trade between the Israeli and Palestinian economies comprises around 70% to 80% of the Palestinian gross domestic product, said Raja Khalidi, an economist and director-general of the West Bank-based Palestine Economic Policy Research Institute.

“Certain levels of trade will be crippled," he said. Expiration of the waiver would create inflation for Palestinians, and affect the Israeli economy, as well as its security, he said.

“Not renewing the waiver will immediately lead to more illicit transactions," he said. “It will effectively create a black market for trade and other transactions between Palestinians and Israelis."

The Palestinian Authority is experiencing a fiscal crisis, according to a recent World Bank report, which said its budget deficit is expected to reach $1.9 billion this year.

“In the absence of financing alternatives, covering such a deficit is expected to prove almost impossible for the PA and may pose elevated risks for a systemic collapse," the report said. “Safeguarding correspondent banking relationships between Palestinian banks and Israeli banks continues to be essential."

After the Hamas-led attacks that killed around 1,200 people and saw some 250 taken hostage on Oct. 7 of last year, Israel canceled more than 100,000 work permits for West Bank Palestinians, cutting off a key source of revenue stream for the roughly three million Palestinians who live there.

The Palestinian Authority is seen by the U.S. and other international allies as a potential alternative to Hamas in Gaza. Smotrich and other Israeli leaders, including Netanyahu, have accused the Authority of supporting terrorism against Israelis and oppose it taking over the enclave, though some in the Israeli security establishment support the option.

The Palestinian Authority says it often cracks down on militant groups in the West Bank, including by arresting members of armed groups.

The signatories of the letter include finance ministers from Japan, Canada, the U.K., the Netherlands, Australia and France.

The letter also raises Israeli concerns about illicit financing for terrorism in the Palestinian territories but states that a report by the Treasury Department determined that “financial institutions within the West Bank maintain adequate controls to manage this risk." The letter added that the Palestinian Authority, which receives technical assistance from the World Bank, is working to further strengthen its anti-money-laundering and antiterror funding efforts.

There is still ongoing work to look into the illicit financing both by Israel and international teams, according to a person familiar with the matter.

The letter came before Israel’s parliament opened its winter session on Monday after a three-month recess. The parliamentary session is likely to exacerbate tensions between Netanyahu and Defense Minister Yoav Gallant, advisers say, as Netanyahu’s coalition needs to secure support to pass a budget by the end of the year or risk snap elections.

Netanyahu is facing pressure from ultraorthodox political partners to secure sweeping military exemptions for their base. Gallant has pushed back against such exemptions.

Earlier this month, Gallant sent a letter to Netanyahu and the cabinet, urging an update to Israel’s war goals that would further give priority to a deal to release hostages held in Gaza since the Oct. 7 attacks. Gallant framed his message as Israel needing to better turn its operational successes into strategic successes, according to a person who has seen the letter.

Netanyahu’s office on Sunday slammed Gallant for writing that the war needed more strategic direction, and said that “the goals are constantly being reviewed, and have even been expanded recently."

The two leaders have a history of tension, and Netanyahu in recent weeks had been evaluating swapping out Gallant for a defense minister who would be more aligned with his political considerations, Israeli officials familiar with the matter have said.

Carrie Keller-Lynn contributed to this article.

Write to Anat Peled at anat.peled@wsj.com and Omar Abdel-Baqui at omar.abdel-baqui@wsj.com