The decision, affecting some 200 listings, would take effect in the coming days, Airbnb said. Its settlements there are considered illegal by most world powers.
Palestinians and their supporters had long lobbied Airbnb to delist the settlements.
Airbnb, which says it operates in 191 countries, will face a backlash from within Israel and from its worldwide backers, who have fiercely fought attempts to delegitimise Israel's control of the West Bank.
"We concluded that we should remove listings in Israeli settlements in the occupied West Bank that are at the core of the dispute between Israelis and Palestinians", a statement on the Airbnb website said.
"Through earning fees from settlement vacation rentals, Airbnb is directly profiting from the continuing occupation and dispossession of Palestinians", a 2016 petition launched by rights groups, including Jewish Voice for Peace and CODEPINK, reads.
However, he said the company should have followed "the position of global law that Israel is the occupying power and that Israeli settlements in the West Bank, including occupied East Jerusalem, are illegal and constitute war crimes".
The announcement came before the publication on Tuesday of a damning report by the New York-based advocacy group Human Rights Watch on the negative implications of its settlement business.
"Airbnb's decision to end its listings in Israeli settlements is an important recognition that such listings can't square with its human rights responsibilities", he said in a statement.
Now that Airbnb, a company valued at $31 billion in 2017, has chose to ban rentals in the area, Israeli Strategic Affairs Minister Gilad Erdan has called on former hosts on the platform to sue the company in accordance with the country's laws banning boycotts.
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Saeb Erekat, the PLO's secretary general, said Airbnb's decision was "an initial positive step".
Israeli Tourism Minister Yariv Levin called Airbnb's move "the most wretched of wretched capitulations to the boycott efforts".
"The decision does an injustice to Israelis living in [the West Bank], constitutes a surrender to extremists and is a mistake that distances peace", Oded Revivi said in a statement.
"Airbnb is the latest target of the NGO network's anti-Israel boycott campaign", said Professor Gerald Steinberg, founder and president of NGO Monitor.
"The Tourism Minister has ordered his office to formulate immediate measures to limit the company's activity throughout the country", Levin's office said in a statement.
In its calls for boycott, the BDS movement does not differentiate between Israel proper and the West Bank settlements - a distinction that Airbnb does make in its decision.
"National conflict [sic] exist throughout the world and Airbnb will need to explain why they chose a racist political stance against some Israeli citizens", Erdan said, as reported by Haaretz.
Some 500,000 Israelis live in the West Bank and East Jerusalem, areas that are also home to more than 2.6 million Palestinians. "The businesses also benefit from these violations, as well as Israel's discriminatory policies that privilege settlements at the expense of Palestinians", the group said.