Court President Aharon Barak gave the ruling in response to petitions by human rights groups on Thursday, saying the practice violated international law
In August 2002, the court had issued a temporary injunction against the practice. But human rights groups have said the military has repeatedly violated the ban since.
In Thursday's final ruling, Barak said the practice amounts to a "slide down the slope towards a severe violation of international law".
Marwan Dallal, an attorney for the Israeli human rights group Adallah, said: "It's an important decision, but we need to see if the military will abide by it."
The human shield practice became an issue in the spring of 2002, when the Israeli military carried out a major offensive in the West Bank.
During arrest raids, soldiers would sometimes force uninvolved Palestinian civilians to approach the homes and hideouts of wanted people. In some of these cases, civilians were caught in the crossfire and were wounded or killed.