Sources in the US congress said on Thursday about $220 million could be cut from the loan guarantees to Israel due to settlement growth in the occupied West Bank and Gaza Strip.
Under international law, these settlements are illegal, a stance not recognised by Israel.
Israel has also refused to halt the construction of a barrier cutting off some of the most fertile areas of the West Bank, dividing farmers from their lands and cutting off villages.
Israel says the wall is aimed at preventing resistance fighters from entering their territory. But Palestinians fear the wall will demarcate the borders of a future state.
Washington has deducted the cost of settlement construction from Israeli loan guarantees in the past. But this would be the first time they would reduce the guarantees due to Israel's building of the barrier.
“According to (US) legislation, the Americans should deduct investments (by Israel) beyond the Green Line,” said senior deputy Accountant-General Eldad Fresher, referring to the boundary between Israel and the West Bank.
Israeli officials said they expected the total amount of money deducted from the US loan guarantees would be small in size and would come from loan instalments in future years.
US President George Bush harshly criticised Israel's expansion of settlements in the occupied territories and its building of the barrier on Wednesday.