Payday lender Wonga said it would write off the debts of 330,000 customers whose loans would not have been approved under new affordability guidelines.
Sky sources said the cost of writing off the debt will be £35m.
There is £220m debt outstanding for the customers affected, at an average loan value of £667.
The short-term lender said it would contact the borrowers by 10 October.
City watchdog the Financial Conduct Authority (FCA) said the 330,000 customers who are currently in excess of 30 days in arrears will have the balance of their loan written off and therefore owe Wonga nothing.
And some 45,000 customers who are between zero and 29 days in arrears will be asked to repay their debt without interest and charges and will be given an option of paying off their debt over an extended period of four months.
The news comes just days after the company reported a massive drop in earnings.
Wonga's annual profit has dropped by 53%, after the payday lender came under fire for the tactics it uses to reclaim money from borrowers in default.
It said full-year pre-tax profit in the 12 months to 31 December were £39.7m, down from £84.5m a year earlier.
The company came under fire over its previous tactic of sending customers in default fake legal letters.
FCA director of supervision Clive Adamson said: "We are determined to drive up standards in the consumer credit market and it is disappointing that some firms still have a way to go to meet our expectations.
"This should put the rest of the industry on notice - they need to lend affordably and responsibly.
"It is absolutely right that Wonga's new management team has acted quickly to put things right for their customers after these issues were raised by the FCA."
The announcement was made after new Wonga chairman Andy Haste completed discussions with the FCA.
Mr Haste said: "It's clear to me that the need for change at Wonga is real and urgent.
"Our regulator is determined to improve standards in consumer credit and I share that determination.
"There is much to do in order to make Wonga a sustainable and accepted business, and today's announcement is a significant step forward in that process."
He added: "We want to ensure we only lend to those who can reasonably afford the loan in question and during my review, it became clear to me that this has unfortunately not always been the case.
"I agreed with the concerns expressed by the FCA and as a consequence of our discussions we have committed to taking these actions."
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