It will be the largest civil penalty in Australian history.
Attorney-General Christian Porter said the massive fine should serve as a wake-up call for the banking industry.
Westpac has admitted to breaking international fund transfer laws 23 million times, leaving the country's financial system exposed to criminal exploitation.
Some suspicious transactions that slipped under the radar were linked to child abuse.
Westpac chief executive Peter King has apologised for the bank's failings.
"We are committed to fixing the issues to ensure that these mistakes do not happen again," he said in a statement on Thursday.
"We have also closed down relevant products and reported all relevant historical transactions."
Westpac shares fell 2 percent in response to the penalty.
Treasurer Josh Frydenberg has cautioned the bank against passing the cost onto customers.
"Westpac will have to recoup this penalty and we don't want it to be coming from the pockets of customers," he said.
"We want it to be coming from the activities of the bank more generally."
Westpac failed to report more than 19.5 million international fund transfers worth more than $11 billion to Australia's financial crime agency.
AUSTRAC chief executive Nicole Rose said such a large number of breaches over several years was unacceptable and could have been avoided.
She hopes the settlement sends a strong message to other lenders.
"Our role is to harden the financial system against serious crime and terrorism financing and this penalty reflects the serious and systemic nature of Westpac's non-compliance," Ms Rose said.
Westpac failed to pass on information about the origin of some transfers and the source of funds to other banks, leaving those lenders exposed.
It did not keep proper records or appropriately assess and monitor the risks associated with moving money in and out of Australia from high-risk jurisdictions.
Nor did the bank carry out appropriate customer due diligence in relation to suspicious transactions linked to possible child exploitation.
The fine eclipses a $700 million penalty recently paid by the Commonwealth Bank over almost 54 million breaches in 2017.
It also dwarfs a $1.2 million penalty handed to the American-owned State Street bank earlier this month for failing to declare money movements.
State Street failed to report 99 foreign fund transfers, copping $12,000 per breach.
The financial transparency laws are in place to stamp out crimes such as terrorism, child exploitation, drug trafficking and tax evasion.
