The ex-Swindon frontman was signed by former Easter Road boss Pat Fenlon last summer in a reported £200,000 deal.
But the 23-year-old failed to impress during his 12-month stay in the Scottish capital, netting just six times in 40 outings.
And he was not used at all by Terry Butcher - Fenlon's replacement - during either leg of their play-off final defeat to Hamilton which saw Hibs relegated from the Scottish Premiership.
Collins has now returned to Greenhous Meadow, where he first enjoyed a spell on loan from Aston Villa in 2011.
However, it is understood that no fee has been paid for his capture, despite Hibs shelling out their six-figure sum just a year ago.
New Hibs chief executive Leeann Dempster said: "Everybody connected to the club would like to wish James all the best as he embarks on the next chapter of his career. We've agreed a mutually beneficial deal with Shrewsbury and now we move on."
Collins follows ex-captain James McPake, former Scotland midfielder Kevin Thomson and goalkeeper Ben Williams out the door after Butcher told the group their contracts would not be renewed.
Also released were Paul Cairney, Bradley Donaldson, David Gold, Paul Grant, Dean Horribine, Alan Maybury, Sean Murdoch and Tom Taiwo, while loan players Daniel Boateng, Danny Haynes and Duncan Watmore have all gone back to their parent clubs.
Shrewsbury Town's chief executive Matt Williams welcomed the return of the Irish Under-21 international to the Sky Bet League One outfit.
"It is a fantastic signing for us and I'm sure that the return of Collo will please the Town fans," he said.
"James has been our number one target and a lot of time and effort from the chairman and manager has gone into this deal and we are delighted to have reached an agreement with Hibs to secure James for the next two years."