RAMALLAH, West Bank — Two major Israeli banks have warned they may sever critical financial ties with Palestinian banks operating in the West Bank, raising concerns of a severe disruption to the territory’s already fragile economy. The potential move threatens to halt many essential imports and could be tantamount to an economic blockade, Palestinian officials and analysts say.

The Israel Discount Bank has formally notified its Palestinian counterparts that it intends to end its correspondent banking services by September 1. Bank Hapoalim is also reportedly considering a similar step. Correspondent banking relationships allow the Palestinian banks to process transactions that facilitate imports and exports, including vital goods such as food, fuel, electricity, and water. Palestinian officials warn that the loss of these banking connections would isolate the West Bank financially, complicating trade with Israel and the broader international community.

Palestinian financial authorities convened a meeting in Ramallah on Thursday, organized by the Palestine Monetary Authority with participation from the United Nations, World Bank, and International Monetary Fund, to address the looming crisis. Titled “The Breaking Point: Sounding the Alarm Before Collapse,” the gathering underscored the deep anxiety over the potential cutoff. Feras Milhem, former governor of the Palestine Monetary Authority, described the situation as a source of widespread fear but expressed hope that Israel would avoid a total severance due to the likely instability it would trigger.

The root of the conflict lies in the Israeli banks’ concern over exposure to legal risks, including lawsuits alleging money laundering or terrorism financing through their Palestinian counterparts. These banks have historically relied on indemnification letters from the Israeli government to shield them from such risks. However, Finance Minister Bezalel Smotrich has leveraged these letters to press the Palestinian Authority on political concessions while limiting the duration of indemnification to short periods, sometimes lasting only weeks. This pattern has fueled mounting frustration within the Israeli banks over the uncertainty surrounding their legal protections.

An aide to Smotrich characterized the Palestinian financial system as complicit in illicit activities, asserting that Israel’s responsibility to mitigate risks is misplaced unless Palestinians address alleged terrorism financing. However, experts including former U.S. Treasury official Daniel L. Glaser have highlighted steps taken by the Palestinian banking sector and monetary authority to restrict militant access, emphasizing the institutions’ opposition to groups like Hamas.

Trade with Israel accounts for 55 percent of Palestinian imports and 85 percent of exports, making the banking connections vital. The correspondent banks facilitate nearly all financial transactions linked to this trade. Palestinians use the Israeli shekel as their main currency, and alternatives such as currency swaps or adopting another currency are viewed as short-term or risky solutions, given Oslo Accord restrictions that prohibit Palestinian currency issuance.

The Israeli government acknowledges the economic risks of the banks’ withdrawals and is reportedly seeking a way to maintain ties, though previous attempts to establish a government-backed intermediary have faltered amid legislative and political hurdles. With Israeli elections approaching and parliament in recess, a swift legislative fix appears unlikely.

Palestinian officials warn that the severance of correspondent banking could quickly lead to shortages of essential goods and energy, deepening an economic crisis already intensified by Israel’s punitive measures following the Hamas attack in October 2023. These measures include withholding customs revenues and canceling work permits for thousands of West Bank laborers.

Economists warn that if the formal banking route collapses, black market alternatives could emerge, facilitating cash transactions that increase vulnerabilities to exploitation by militant groups. Milhem called the situation not only a humanitarian concern but also a significant security threat, highlighting the potential broader implications of the banking crisis on regional stability.