Thirteen ministers voted for the proposal to upgrade the status of the College of Judea and Samaria in Ariel while seven voted against on Monday.
Public radio said Education Minister Limor Livnat had proposed the upgrade in response to a British academic boycott of Bar Ilan University, close to Tel Aviv, which was imposed last month on the basis of its involvement with the College of Judea and Samaria.
Ariel, home to about 17,000 settlers, is situated 20km to the east of the internationally-recognised border between Israel and the West Bank.
The decision to upgrade the Ariel institution was taken at the same time that ministers also agreed to combine a number of colleges in northern Israel to create a university in the Galilee region.
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".
The immediate impact of the upgrade is largely symbolic.
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."