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The consulate employee, identified as Romain Franck, is alleged to have smuggled weapons from Hamas-controlled Gaza to the occupied West Bank on five occasions in recent months, the security agency Shin Bet said in a statement.
He used a diplomatic vehicle belonging to the French consulate which are subject to less stringent security checks, it claimed.
Franck, identified by French media as 24 years old, is suspected of having transferred around 70 pistols and two assault rifles.
"The investigation clearly shows that the employee of the French consulate acted for financial gain, on his own initiative and without the knowledge of his superiors," said the Shin Bet statement. "This is a very grave incident in which the immunity and privileges granted to foreign missions in Israel was cynically exploited."
The Shin Bet said Franck had received the weapons from a Palestinian resident of the Gaza Strip employed at the French Cultural Center there. They said he then transferred the weapons to a Palestinian unit in the West Bank. The weapons were later sold them on to arms dealers, the agency said.
"We take this case very seriously and are in very close contact with the Israeli authorities on this case," said a spokesman for the French Embassy in Tel Aviv, adding that Frank was due to appear in court on Monday when the exact charges would become clear. "They are serious."
Israel also said it had also arrested a Palestinian resident of East Jerusalem, who works as a security guard at the French Consulate in Jerusalem, as well as several Palestinians from Gaza living illegally - under Israeli law - in the West Bank in connection with the smuggling ring. Six of the individuals will be indicted by the Southern District Court, the Shin Bet statement said.
Some of the suspects were also involved in smuggling money from the Gaza Strip to the West Bank, the Shin Bet alleged.
Tensions between Israel and Hamas have increased in recent weeks, with Israel accusing the militant groups of sending civilians to protest along its border fence. Gaza residents have held regular protests near the barrier since President Trump declared Jerusalem as Israel's capital, with several shot dead by Israeli security forces.
Rocket fire from Gaza also increased following the announcement, though has died down in recent months.
On Sunday, the Israeli military said it had destroyed a Hamas tunnel built to infiltrate into Israeli territory. On Thursday, the Israeli military said two explosive devices were detonated toward troops on a routine patrol. Last month, four soldiers were injured when an IED went off next to the fence.
"We are seeing Hamas instigate riots, calling on its civilians to march toward fence and engage with our troops," said Lt. Col. Jonathan Conricus, an army spokesman in a briefing with journalists on Thursday. "We are seeing a pattern here and we will not allow it to become standard operating procedure."