JERUSALEM, Feb 3 (Reuters) - An Arab citizen of Israel who crossed illegally into the Hamas-controlled Gaza Strip, raising concern he might be held hostage by militants, was returned to Israel on Wednesday.

Palestinian witnesses said Hamas security forces had taken the 22-year-old man into custody after he climbed over Israel's frontier fence into the Gaza Strip on Tuesday. He was described by his family as mentally unstable.

An Israeli military spokesman said the man was returned after Israeli authorities asked Palestinian officials loyal to President Mahmoud Abbas's Fatah faction, a Hamas rival, to seek his release.

The incident had raised fears in Israel that Palestinian militants might use the Israeli civilian to increase their bargaining power in seeking the release of comrades held in Israeli jails.

Israel and Hamas are bitter enemies, and an Israeli soldier has been held in the Gaza Strip since his capture in 2006 by Palestinian militants who tunnelled into Israel.

German mediation has failed so far to clinch a deal for an Israel-Hamas prisoner exchange in which the soldier, Gilad Shalit, would be traded for about 1,000 of roughly 7,000 Palestinians held in Israeli jails. (Writing by Ori Lewis; Editing by Louise Ireland)