The bank said it will scrap fees for retail customers who fall into unplanned overdrafts from November.
Lloyds - which has about 20 million customers, including with Halifax and Bank of Scotland – will also replace all of its arranged overdraft fees with one charge of 1p per day for every £7 spent.
The FTSE 100-listed company is the first major UK bank to shake-up its overdraft charges following criticism from the Competition and Markets Authority and consumer groups about banking customers being hit with high fees.
The CMA has ruled that banks must cap their monthly maximum charges on unauthorised overdrafts by the start of August. It said about a fifth of current account holders in the UK have unarranged overdrafts, which generated about £1.2bn of revenues for banks in 2014.
The Financial Conduct Authority is expected to propose measures to cap “extortionate” fees for unplanned overdrafts in the next few weeks as part of its inquiry into high-cost credit.
At the moment, Lloyds charges £10 a day for customers that go more than £25 over their overdraft limit. Account holders also face a £10 fee for every payment that is bounced as well as 19.89% interest on the balance.
Under the new regime, a customer with the classic current account who goes overdrawn by £100 within their planned limit for 10 days will pay £1.40 rather than the current £6.38.
The lender, which is now fully private after the UK government sold its remaining stake in May, will also send a free text to customers to alert them if they have started using their overdraft or if their balance is running low.
Vim Maru, who is director of customer products and marketing at Lloyds and will become head of the retail bank this year, said: “This new approach is simple and clear, giving customers more control of their overdraft borrowing and how they manage their finances.”