Lam told a press conference that the project, which could allow China to extradite fugitives from Hong Kong, is temporarily "suspended" to defuse the crisis it has unleashed, Efe news reported.
She added that the goal of the law was to avoid Hong Kong becoming a "safe haven for criminals".
"After studying the matter in the last two days, I announce that we will pause the amendment. We will communicate with society, do more explaining and listen more," Lam told reporters.
"The government will listen with an open attitude to opinions about the bill," she added.
The decision comes after a meeting with members of her Executive Council and calls from several supporters of the regulation on Friday for the suspension of the project.
Protesters have planned another demonstration on Sunday, which has not yet been cancelled and comes in the wake of massive protests that started on Wednesday when thousands took to the streets to demand the government to revoke the controversial bill.
During protests, the police dispersed crowds by firing teargas and rubber bullets which left 81 people wounded. Two of the injured were in a serious condition and 11 people were arrested, authorities said.
"As a responsible government, we should defend law and order. But we also have to make a judgment call, and to protect Hong Kong's best interest," Lam said at the press conference.
Demonstrators are urging the government to condemn the use of force by the police during protests and have demanded that detained protesters be set free.
On the other hand, the central government of Beijing has shown support for police intervention during the protests and for the extradition bill to be made into law.
Lam acknowledged that policies that come with a mainland element could risk confrontation within Hong Kong, adding that the way forward would involve addressing such concerns and boosting confidence in the proposed policy which she defended was designed to avoid Hong Kong becoming a "safe haven for criminals".
"There could be even more serious confrontation. There may be more serious injuries for my police officers and citizens. I don't want any of these injuries to happen," she added.
Opponents of the bill, which include a broad spectrum of Hong Kong society, argued that the new law would leave citizens of Hong Kong unprotected against China due to the lack of checks and balances or separation of power.
Proposed in February, the bill passing into law would allow the Chief Executive's headquarters and the Hong Kong courts to process extradition requests from jurisdictions without prior agreement - in particular mainland China and Taiwan - and without legislative supervision.
( With inputs from IANS )