The Prostitutes' Collective says that retraction doesn't go far enough, and brothels should not be grouped with industries deemed harmful.
The collective's coordinator, Dame Catherine Healey, said 60 per cent of sex work is in managed brothels.
"It's not good to have a policy that draws a line across a class of people who have received certificates from the Ministry of Justice to say that they're fit and proper to operate a brothel."
She worried the bank's stance would fuel the stigma around sex work, which was decriminalised in 2003.
After discussions with the Prostitutes' Collective, Kiwibank decided it would take on businesses which can show good practice.
In a statement, the bank said it would recategorise the adult entertainment industry as a sensitive sector.
"This means Kiwibank will continue to back businesses in that sector who can demonstrate good practice.
"We will be working with NZPC to develop the policy further. We have always banked individual sex workers, and this does not change."
The chief executive of ethical investment charity Mindful Money, Barry Coates, welcomed the bank's revised policy and approved of setting standards on things like fossil fuels.
He could not understand why brothels and strip clubs were initially blocked.
"I don't think it would be at all a good thing if sex worker services were driven underground or further back into the informal economy.
"On the other hand this is Kiwibank's very good development of an overall policy that is headed in the right direction."
The list of businesses Kiwibank says do harm to people or the environment include companies dealing in fossil fuel extraction, tobacco, palm oil, casinos, predatory lending, synthetic drugs and weapons.
Not bank's role to make moral judgments - Shane Jones
Associate Minister for State Owned Enterprises Shane Jones questioned why companies that deal with the extraction, production and manufacturing of coal are included.
He told Morning Report Kiwibank should "get out of the pulpit".
"It's the role of the Crown to regulate whether or not there are bads associated with the extractive sector or any other sector.
"My warning to the chairman of Kiwibank is that the bank that goes woke may end up broke.
"Their role is to moderate the market and to stand as a force for Kiwis, not to make moral judgments ... about what is an appropriate industry that can legally survive in New Zealand."
He said he would be seeking answers from the board chair of NZ Post, which has a controlling stake in the bank.
In response, Kiwibank chief executive Steve Jurkovich said he was more than happy to meet with Government ministers "to discuss the leadership position we have taken, for our customers and New Zealand as a whole".
In a statement he said like all banks Kiwibank considered the industries it should or should not be providing financial support to.
"These are a part of the choices we make as a bank.
"The policy we have introduced sets out our position on a number of sectors which we have determined may harm people or the environment. This aligns to our sustainability commitments and our purpose of making Kiwis better off.
"Like any policy we will continue to revisit its applicability and we are prepared to re-consider our position."
Jurkovich said he would be contacting Jones directly today.
