Prime Minister Malcolm Turnbull said the commission - Australia's highest form of public inquiry - would help restore confidence in the sector.
Australian banks have been embroiled in scandals in recent times.
The announcement came soon after the four biggest banks called for an inquiry in a joint letter, reversing their previous opposition.
"The only way we can give all Australians a greater degree of assurance is a royal commission into misconduct into the financial services industry," Mr Turnbull said.
