Co-Op had been in competition with new bank venture NBNK
Lloyds said it would now enter into more detailed and exclusive talks with the Co-Op, which runs a financial services division along with a supermarket retail arm, and would hope to agree on a deal by the end of the first quarter next year.
The Group will continue to progress an Initial Public Offering (IPO) during this phase of the discussions, added Lloyds.
Acquiring the Lloyds retail branches offers Co-Op the chance to create Britain's seventh-biggest bank in one bold step. Lloyds had given the sale process the code-name of Project Verde.
The Verde assets include 4.6 percent of personal current or checking accounts and 5 percent of the mortgage market, contributing about 500 million pounds of pretax profit in 2008 and income of about 1.4 billion.
(Reporting by Sudip Kar-Gupta; Editing by Myles Neligan)