The newly launched Financial Conduct Authority (FCA) is to be given the power to limit the cost of credit in the face of annual interest rates of up to 4000% which can be charged on short-term loans to see people through until their wages are paid.
Treasury minister Lord Sassoon told the House of Lords the watchdog will also have the power to ensure that loans do not roll over indefinitely.
Consumer groups and MSPs welcomed the measures, with figures revealing Scots are twice as likely to struggle financially as a result of a payday loan compared to the rest of the UK.
There have been calls in Parliament for high-profile firms such as Wonga, which sponsors Hearts, and QuickQuid to be reined in.
Margaret Lynch, chief executive of Citizens Advice Scotland, said: "We need to see more detail of exactly what is being proposed, but there is no doubt the high interest rates associated with payday loans is a huge problem, and has led many families into the misery of debt.
"We have long called for action to tackle this issue, and if the Government is now moving towards restricting these high interest rates then we would see that as a very positive step.
"The high interest rates are the core problem, and tackling these would be the key to saving thousands of people from getting stuck in a spiral of debt."
SNP MSP Dave Thompson, who has also campaigned on the issue, said: "Payday loans promise short financial relief, but in reality are a dream today and a nightmare tomorrow as interest rates increase the loans rapidly.
"This is a welcome announcement, albeit a long overdue one, which will bring us into line with most other European countries."
Independent MSP Margo MacDonald also welcomed the move, adding that any cap should prohibit lenders from charging more than three times the amount borrowed.
The move emerged at the report stage of the Financial Services Bill in the face of a Labour amendment.
Lord Sassoon said he would bring forward a measure when the Bill has its third reading next week if Labour peer Lord Mitchell withdrew his amendment.
He said: "We need to ensure the Financial Conduct Authority grasps the nettle when it comes to payday lending and has specific powers to impose a cap on the cost of credit and ensure that the loan cannot be rolled over indefinitely should it decide, having considered the evidence, that this is the right solution.
"Interest rates charged by many lenders go well beyond the obscene. We have an industry flying by the seat of its pants, observing at best the flimsiest requirements of the law and their own pathetic codes of conduct.
"They need to be much more closely controlled."
Lord Mitchell praised the minister's "very welcome statement of intent". He said: "This issue is now where it should be – beyond party politics.
"The winners are those who live in the hell-hole of grinding debt. The losers are clearly the loan sharks and the payday lending companies. They have tried every trick in the book to keep this legislation from being approved and they have failed.
"Their failure is our victory."
Energy minister Fergus Ewing added the Scottish Government is also exploring further solutions and alternatives to payday loans, including encouraging people to seek advice before applying for further credit.