New policy would see Israel not return bodies of any Palestinian killed during or as a result of attack on Israel, a decision rights groups call "extreme, barbaric" and "illegal".
Israel has decided to withhold the bodies of all slain Palestinian fighters, a move slammed by rights groups as "barbaric".
Prior to the decision, approved by the government's security cabinet, Israel retained the bodies of fighters only from Hamas, the governing group of Gaza.
The new policy would see Israel not return the bodies of any Palestinian killed during or as a result of an anti-Israeli attack.
Defence Minister Benny Gantz welcomed the cabinet's decision, which he said was part of a broader campaign of "deterrence".
"Not returning terrorist bodies is part of our commitment to the safety of Israeli citizens, and of course to returning the boys home," he said, referring to the remains of two Israeli soldiers held by Hamas in Gaza since a 2014 war.
Hamas is also believed to be holding two Israeli citizens who entered Gaza alone and whose families say have mental health issues.
The latest Qatari-led truce was condemned by Leah and Simcha Goldin, the parents of one of the soldiers missing in Gaza.
"The money will be transferred to Gaza, the crossings and fishing zone will open. And the boys? The boys will remain there some more," they wrote on Twitter.
'Extreme, barbaric, illegal'
Rights group Adalah called Israel's decision "extreme, barbaric" and "illegal".
"The policy of using human bodies as bargaining chips violates the most basic universal values and international law which prohibit cruel and inhuman treatment," they said in a statement.
Restoring calm along fence
Palestinian resistance groups and Israel agreed to end a weeks-long escalation of unrest along the Israel-Gaza fence on Monday.
Under the deal, brokered by a Qatari envoy, Hamas would end the launching of incendiary balloons, and Israel would end air strikes, said a Palestinian official close to the mediation.
COGAT, Israel's liaison agency to the Palestinian territories, confirmed that after security consultations led by Gantz, Gaza's main goods crossing would reopen and fishermen would be allowed back to work, up to 15 nautical miles.
A COGAT statement said the decisions were "subject to the continuation of the calm and the security stability" but warned that if Hamas failed to deliver, Israel would "act accordingly."