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We have a security policy that says we must change the default permission levels when creating a new site. Full control for the Owners group is changed to a custom permission level while the Members group changes from 'Edit' to 'Contribute'. When you create a Team site with an O365 Group, the 'Edit User Permissions' button is disabled

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How do we change the permission level of a Team site with a Group?

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We cannot change this through UI interface. However, we can use powrshell to change group permission level. Below is my demo:

connect-sposervice https://tenant-admin.sharepoint.com
Set-SPOSiteGroup -Site https://tenant.sharepoint.com/sites/michael -identity "MichaelGroup Members" -PermissionLevelsToRemove "Edit" -PermissionLevelsToAdd "Contribute"

Please refer to this about Set-SPOSiteGroup cmdlet: https://docs.microsoft.com/en-us/powershell/module/sharepoint-online/set-spositegroup?view=sharepoint-ps

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This is how Group connected sites function, I would recommend creating your sites as non group connected so you can customize the permission in the manner that you need to. You can still use O365 groups for permissions without the site being group connected.

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