Israel's state prosecutor has failed in a bid to see Malka Leifer, the former principal of an ultra-Orthodox girls school in Melbourne, returned to house arrest in Israel.

Key points: Last week Leifer was ruled mentally unfit to face extradition and had her home detention lifted

Last week Leifer was ruled mentally unfit to face extradition and had her home detention lifted A bid to have Leifer returned to house arrest and her bail lifted has failed

A bid to have Leifer returned to house arrest and her bail lifted has failed Alleged victim says she is very disappointed, 'can't understand how this happened'

Leifer is wanted by Victorian police on 74 charges of indecent assault and rape allegedly involving girls at the Adass Israel School in Melbourne, where she was principal from 2003 until 2008.

Last Thursday, Leifer was ruled mentally unfit to face extradition and had her home detention lifted in a move that shocked and deeply concerned Australian officials and outraged her alleged victims and Jewish community leaders in Melbourne.

Legal proceedings around her extradition were stopped for six months, during which time she will undertake court-ordered psychiatric treatment.

The ABC understands Israeli prosecutors had hoped to argue that because the case was an extradition request, the judge had the authority to continue Leifer's home detention despite proceedings being frozen.

However, in the Jerusalem District Court on Tuesday, Judge Winograd did not accept legal debate from prosecutor Mattan Akiva over the issue of Leifer's house arrest being re-instated.

The prosecutor also requested Leifer's bail be lifted from 100,000 Israeli shekels ($AU35,000) to 200,000 Israeli shekels ($AU70,000).

But Judge Winograd also refused this request, saying that because there was no evidence Leifer had breached her previous bail conditions, the bail should be returned in full.

The prosecution has 48 hours to appeal the full return of the bail.

Leifer's passport would not be returned to her and she would remain banned from leaving the country.

Alleged victim 'can't understand how this happened'

Deputy ambassador to Israel James McGarry says he will follow the case closely. ( ABC News: Sophie McNeill )

One of Leifer's alleged victims, Rebecca (not her real name), told the ABC she was disappointed the house arrest could not be appealed.

"I'm also outraged she has had her bail returned. I can't understand how this happened," Rebecca said.

Australia's deputy ambassador to Israel, James McGarry, attended court proceedings, and told the ABC the embassy would continue to follow the case closely until Leifer was extradited.

"We continue to work with Israeli authorities to give them any assistance they need to finalize this extradition matter," he said outside the courtroom.

A relative of Leifer who attended court refused to comment on allegations raised in a Melbourne newspaper that members of the Addas Israel community in Melbourne were sending money to Israel to support the fugitive principal.

In 2008, after accusations were first raised against her, the former principal fled to Israel with her family in the middle of the night, allegedly with the help of senior members of Melbourne's secretive Adass community.

For two years, she has managed to evade 10 extradition proceedings, claiming that she faces panic attacks whenever scheduled court dates arise and that she is too unwell to attend court.

In a civil case against the Adass Israel School and Leifer, last September a Melbourne judge awarded one of the alleged victims $1.27 million in damages.