By David Lawder
STRESA, Italy (Reuters) -U.S. Treasury Secretary Janet Yellen said on Thursday she was concerned by a threat from Israel to cut off Palestinian banks from their Israeli correspondent banks, a move that would close a critical lifeline for the Palestinian economy.
Yellen told a news conference ahead of a G7 finance ministers meeting beginning on Friday that the U.S. and its partners "need to do everything possible to increase humanitarian assistance to Palestinians in Gaza, to curtail violence in the West Bank, and to stabilize the West Bank's economy."
She said she would bring up the issue at the meeting of the Group of Seven industrial democracies in the lakeside resort town of Stresa in northern Italy.
"I expect other countries to express concern about the impact of such a decision on the West Bank economy. I think this would have a very adverse effect also on Israel."
Israel's Finance Minister Belazel Smotrich has said he cannot renew a waiver that expires on July 1 which allows Israeli banks to process shekel payments for services and salaries tied to the Palestinian Authority.
In a post on the X social media site reacting to Yellen's comments, Smotrich said he could not sign the waiver because Palestinians are still funding "terrorism" and Israeli banks can be sued for violating anti-terrorism financing laws.
"The financial system of the Palestinian Authority is infected with terrorism up to its neck," said Smotrich, a member of a far-right Israeli coalition partner that supports settlements in the West Bank. He called critics of the policy "hypocrites."
Palestinian Monetary Authority said on Thursday that cutting off Palestinian banks from their Israeli correspondent banks will have negative impacts on both the Palestinian and Israeli economies.
"The Palestinian banking system maintains correspondent banking relationships with a wide network of banks around the world that qualify it to continue providing services to citizens locally and globally, as banking relationships with the outside world will not be affected in all cases," the authority added in a statement.
Yellen said it was important to keep open the Israeli-Palestinian correspondent banking relationships to allow battered economies in the West Bank and Gaza to function and help ensure security.
"These banking channels are critical for processing transactions that enable almost $8 billion a year in imports from Israel, including electricity, water, fuel, and food, as well as facilitating almost $2 billion a year in exports on which Palestinian livelihoods depend," Yellen said.
She added that Israel's withholding of revenues collected on behalf of the Palestinian authority also threatens the West Bank's economic stability.
"My team and I have also engaged directly with the Israeli government to urge action that would bolster the Palestinian economy and, I believe, Israel's own security," Yellen said.
Financial tensions between Israel and the U.S. have risen over U.S. sanctions imposed on Israeli settlers in the West Bank.