The London-based Al-Sharq al-Awsat reported Friday that Hamas's military wing vetoed a 'good deal' offered by Israel.
French President Nicolas Sarkozy and German Chancellor Angela Merkel called Friday for the release of kidnapped IDF soldier Gilad Shalit.
Schalit has been held by the Hamas terrorist organization for five years without visits from international bodies such as the International Committee of the Red Cross (ICRC).
Sources from Merkel's office said a draft of a final agreement for Shalit's release prompted the joint statement. German mediators in the Shalit deal reportedly visited Gaza two months ago.
According to the sources 1,000 Palestinian Authority Arab prisoners would be handed over in exchange for Schalit, but the Hamas military wing vetoed the proposal.
Other sources close to the negotiations indicated France and Germany offered to extend de facto recognition to the Hamas government in Gaza, which would allow for European investment in the territory, and were working to ease border restrictions.
Prime Minister Benjamin Netanyahu "offered Hamas a good deal, better than anything offered by Olmert," Al-Sharq al-Awsat" said.
Hamas's political leadership accepted the proposal, but the military leadership, which has ties with Iran, rejected it," the report said.
Egypt, another mediator in the deal, was also reportedly involved in trying to broker a deal for Schalit's release.
"We have once again taken up managing the matter and we will work according to what we believe are better and improved terms within the framework of the changes that must be made," Egyptian officials told al-Hayyat.
Israeli officials have refused to respond to the report.