Canberra's decision comes amid worsening relations between Palestine and Australia's key ally the United States
Australia ended direct aid to Palestine on Monday over fears it could be used to support people convicted of political violence.
Canberra will halt the $7.5 million per year it gave to the World Bank's trust fund for Palestine’s recovery and development, Foreign Minister Julie Bishop said.
"I wrote to the Palestinian Authority on May 29, to seek clear assurance that Australian funding is not being used to assist Palestinians convicted of politically-motivated violence," she said in a statement.
"I am confident that previous Australian funding to the PA through the World Bank has been used as intended.
"However, I am concerned that in providing funds for this aspect of the PA's operations there is an opportunity for it to use its own budget to activities that Australia would never support."
Australia will instead send the money to the United Nations' Humanitarian Fund for Palestine, which provides vulnerable Palestinians with access to health care, food, water, improved sanitation and shelter.
The fund helps 1.9 million people and around three-quarters of its money is spent in Gaza, where living conditions are deteriorating as tensions increase with Israel.
Canberra's decision comes amid worsening relations between Palestine and Australia's key ally the United States.
US President Donald Trump's administration sparked anger across the Arab world in December by recognizing Jerusalem as capital of the Jewish state.
The Palestinian leadership responded by freezing all contacts with US officials.