Israeli Government Delays Legislation to Rescue Palestinian Banks Amid Looming Financial Crisis

Palestinian commercial banks in Ramallah, Nablus, and Hebron currently hold about 15 billion shekels in cash issued by the Bank of Israel, which cannot be converted into digital currency. This situation precedes a deeper crisis: Bank Hapoalim and Bank Discount have officially notified their Palestinian counterparts and Israel's Finance Ministry that they will cease correspondent banking services within a month. Correspondent banking enables shekel transfers between Palestinian banks and Israeli banks, crucial for transactions such as the Palestinian Electricity Company paying the Israeli Electricity Company and Palestinian merchants paying Israeli suppliers. Approximately 90% of Palestinian trade passes through Israel, with these two banks processing around 51 billion shekels annually.

Yahya Shunnar, Governor of the Palestinian Monetary Authority, described the situation as a "cliff," not a slope, during a briefing with diplomats in Ramallah. A conference titled "Breaking Point," convened by the Palestinian Monetary Authority alongside UN, World Bank, and IMF representatives, highlighted the systemic risk posed by the uncertainty surrounding correspondent banking. In May, the World Bank warned that this uncertainty is an immediate systemic risk to the Palestinian financial sector.

The issue has transcended economic debate. In late 2024, the foreign ministers of Britain, France, and Germany jointly urged Israel to extend indemnity letters for Palestinian banks transparently and free from political considerations. Two years later, amid a more hostile international atmosphere, a collapse of the banking system in the West Bank would be seen globally as a political decision for which Israel would bear diplomatic responsibility.

Israeli banks entered this arrangement reluctantly in the mid-1990s following the Oslo Accords and the Paris Protocol, which linked two financial systems sharing one currency. Since then, they have sought to exit. In 2017, the Israeli government agreed to establish a government-owned company to assume this role and release the banks from liability. This company, led by Dr. Gitit Gur-Gershgoren, is technically ready but has not operated due to stalled legislation since 2022. The government has delayed approving the necessary legal amendments, unwilling to endorse a law enabling Palestinian banks to continue functioning, especially after the October 7 attacks.

Instead, the Finance Ministry has extended indemnity letters to banks every six months, with the latest valid until the end of 2026. Banks have been asked to continue operations for a few more months until after Israel’s October 27 elections, pushing the problem to the next government, which may only be sworn in in early 2027. However, the banks plan to exit the correspondent banking system by the end of August, before the indemnity expires, due to risks of terrorism financing lawsuits and strained international banking relations.

The government argues that transferring payment clearing to a government company would expose Israel itself to terrorism financing lawsuits, unlike commercial banks that can be indemnified. Yet, Israel is already fully exposed through the indemnity letters, without control over the mechanism, which is the worse scenario.

Meanwhile, cash accumulates in Palestinian banks. The Bank of Israel annually collects about 18 billion shekels from Palestinian banks, based on a quota estimating legitimate consumption such as Palestinian workers’ salaries and purchases by Israelis in the territories. Despite a sharp drop in Palestinian workers in Israel from 100,000 to 20,000, the quota has not been updated, causing excess cash to pile up, raising concerns about illegal activity and money laundering.

The cash collected is credited to accounts held by Palestinian banks at Bank Hapoalim and Bank Discount, the very banks exiting correspondent banking. Thus, the shutdown will disrupt both cash flows and payment transfers simultaneously. Attempts to shift to digital payments are hindered by bureaucratic obstacles and international credit card companies classifying transactions in Ramallah as cross-border, incurring extra fees. This incentivizes merchants to prefer cash, perpetuating the problem.

The Palestinian Authority faces a severe budget crisis due to frozen clearance revenues, which constitute two-thirds of its income. It is also the largest borrower from Palestinian banks, which finance salaries and deficits. A banking collapse would topple the Authority and the civil and security coordination in the West Bank.

Israeli companies supplying electricity, fuel, food, and medicine to the Palestinian market, which involves tens of billions of shekels annually, will face unpaid debts. Uncollectible debts are lost debts, and unmonitored cash flows will eliminate valuable intelligence currently generated by the banking system.

Paradoxically, the Finance Ministry itself acknowledged that ending correspondent banking could harm regional economic stability and increase money laundering and terrorism financing risks by pushing activity into unregulated cash channels. This is precisely the outcome of failing to pass the stalled legislation. The solution exists, is ready, and connected, but lacks a government willing to implement it.