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Israeli Prime Minister Binyamin Netanyahu on Sunday called for the United Nations' agency for Palestinian refugees UNRWA to be closed, days after US President Donald Trump threatened to cut Palestinian aid.

Last week, Trump admitted the Middle East peace process was in difficulty and threatened to cut US aid to Palestinians, currently worth more than $300 million a year.

The aid cuts include payments to the UN Relief and Works Agency (UNRWA), an agency set up in 1949 to provide for the hundreds of thousands of Palestinians displaced during Israel's creation.

Israel has long criticised the UN agency as biased against it, an allegation UNRWA strongly denies, while criticising the agency's method of classifying refugees, with descendants also eligible to register.

"UNRWA is an organisation that perpetuates the Palestinian refugee problem," Netanyahu said while also lauding Trump at the beginning of his weekly cabinet meeting.

He said that while millions of other refugees around the world were cared for by the office of the UN High Commissioner for Refugees (UNHCR), the Palestinians have their own body which also treats "great-grandchildren of refugees - who aren't refugees".

"This absurd situation must be ended," Netanyahu said.

UNRWA spokesman Chris Gunness said that its mandate came from the UN General Assembly "whose members give wide and strong support to the agency's humanitarian and human development mission".

"What perpetuates the refugee crisis is the failure of the parties to deal with the issue," he wrote in a statement.

"This needs to be resolved by the parties to the conflict in the context of peace talks, based on UN resolutions and international law."

In June, Netanyahu said he had raised the issue with Washington's UN envoy Nikki Haley.

The US has long provided the Palestinian Authority with much-needed budgetary support and security assistance, as well as an additional $304 million for UN programmes in the occupied West Bank and Gaza.

The Axios news website reported on Friday that Washington had frozen $125 million in funding for UNRWA, but a State Department official said no decision had been made.

UNRWA runs hundreds of schools for Palestinian refugees in the Gaza Strip, the occupied West Bank, Israeli-annexed east Jerusalem, Lebanon, Jordan and Syria.

It also distributes aid and provides teacher training centres, health clinics and social services.

Many analysts, including Israelis, warn that closing the agency without having an effective replacement could lead to further poverty and perhaps violence.