Mr Bannon's appointment to the NSC in January caused uproar among critics of the President, who said it was inappropriate for the political adviser to play a role in national security matters.
While opponents of the administration construed Bannon's removal from the NSC's principals committee as a setback, a White House official told Bloomberg that his removal from the committee was not a demotion. The memo no longer lists the chief strategist as a member of the Principal's Committee, a group of high-ranking officials that convene to discuss pressing national security priorities.
And in another change, the national security adviser will set the agenda for the council as well as for the Homeland Security Council, and can delegate that at his discretion.
Washington observers were startled after Mr Trump took office when Mr Bannon, a person with minimal foreign policy experience, was given a senior role on the council.
Flynn was forced to resign on February 13 over his contacts with Russia's ambassador to the United States, Sergei Kislyak, prior to Trump's taking office on January 20.
The 63-year-old, formerly the head of right-wing website Breitbart News, has been replaced in the NSC by director of National Intelligence Daniel Coats and Joint Chiefs chairman Joseph Dunford.
Bannon became Trump's chief strategist after leaving his role as a founder and editor-in-chief of Breitbart News-which he lauded as the "voice of the alt-right"-to run the "Make America great again" campaign".
The official said Bannon had been placed on the NSC originally as a check on Flynn and had only ever attended one of the NSC's regular meetings.
The White House has sought to give back a lot of control to the Defense Department and other national security agencies.
Under the new arrangement, Bannon can still participate in NSC meetings, but not necessarily all NSC meetings. Bannon will maintain his security clearance as is standard for most top West Wing officials.
"General McMaster has returned the NSC to its proper function", Bannon added.