The decision on Monday means turning one of Bar Ilan University's colleges into an independent university in the Ariel settlement, south of the West Bank city of Nablus.
The decision was made after British university professors decided to boycott Haifa and Bar Ilan universities on the grounds of the latter's involvement with the college, Aljazeera's correspondent in Palastine reported.
Agencies reported quoting an Education Ministry spokeswoman that 13 ministers backed the proposal to upgrade the status of the College of Judea and Samaria in Ariel, while seven voted against the proposal at the weekly cabinet meeting.
Ariel, which is home to about 17,000 settlers, lies 20km to the east of the internationally recognised border between Israel and the occupied Palestinian territory.
Palestinian cabinet minister Ghassan al-Khatib called the decision to upgrade the college a dangerous step at a time when a ceasefire has buoyed hopes for a renewal of peace negotiations.
Also on Monday, Israeli cabinet minister Natan Sharansky resigned in protest against Israeli Prime Minister Ariel Sharon's plan to pull out of the Gaza Strip, his office said.
In his letter of resignation to Sharon, he wrote: "As you know, I was opposed to the disengagement plan from the outset, on the basis of my deep belief that every concession in the peace process made by the Israeli side must be accompanied by democratic reform on the Palestinian side."
An outgoing minister has termed
Sharon's plan 'a tragic mistake'
He told Israel Army Radio that he considered the disengagement plan "a tragic mistake that exacts a high price and also encourages terror".
Sharansky, a former Soviet dissident, had served as minister without portfolio in the cabinet.
All 8000 Israeli settlers are due to be pulled out of Gaza during an operation starting in July or August.
With regard to the cabinet approval of the move to set up a university in the West Bank, Sharon said: "This is in keeping with government policy, which views strengthening the settlement blocs as being among its goals."
He added: "Converting the college into a university is in keeping with government policy."
Although the immediate impact of the upgrade is largely symbolic, it was hailed by the mayor of Ariel as the successful culmination of a lengthy campaign.
"This is in keeping with government policy, which views strengthening the settlement blocs as being among its goals"
Israeli Prime Minister Ariel Sharon
"We have been working towards this decision for the last eight years. This is a very significant decision by the Israeli government," Ron Nachman told AFP.
The mayor said he did not believe "that the college received this recognition for political purposes "but rather as a result of its research work.
The decision, however, is bound to have political ramifications, with the college being upgraded in an area where the Israeli government is obliged to freeze all construction work under the internationally drafted road map peace plan.
Facts on the ground
Ariel is a particular sensitive area as it lies so deep inside the West Bank, and the government has so far had to hold off on plans to bring the settlement inside the route of its controversial separation barrier in the territor.
Dror Etkes, a leader of the anti-settlement watchdog Peace Now, said the move was another sign of the government's determination to create facts on the ground and thus make it harder for Israel to leave the area.
The proposal was backed by 13
ministers in the Israeli cabinet
"This shows very clearly that the Sharon government is trying to do everything possible to annex the Ariel block," he told AFP.
The Israeli government had initially responded to the boycott vote by the Association of University Teachers, Britain's largest university teachers union, by denouncing it as a "biased and iniquitous decision".
A spokeswoman for the Education Ministry said the change in status did not mean that the college in Ariel would receive any extra funding in the short-term.
"The minister will not ask for any more money for five years," the spokeswoman said. "Everything will stay the same."