NETANYA, Israel – Two blocks from the beach on a spring day here in March 2003, a 20-year-old Palestinian named Rami Ghanem walked up to the London Cafe and blew himself up, shattering the cafe's 15-foot-high windows and seriously wounding more than 35 people.

Hours later, the Syrian-based terror group Palestinian Islamic Jihad took credit for the attack, while the Israeli military demolished the house where Mr. Ghanem lived with his parents. A few weeks afterward, Mr. Ghanem's father received at least $14,000 from an account at Jordan's Arab Bank PLC -- money that was delivered thanks to a local Islamic charity, according to Israeli documents. In an interview at his new house in a West Bank village, the elder Mr. Ghanem said he believes the funds were sent by Islamic Jihad.

Arab Bank is now at the center of a diplomatic dilemma for the U.S. In lengthy dossiers, the Israeli military and U.S. bank regulators have traced how large sums often flowed from suspected terrorist fund-raisers through the bank's New York branch into accounts at the bank's Mideast branches. In many instances these accounts were controlled by charities affiliated with terrorist groups.