Payday lender Wonga says it is writing off £220m of debts for 330,000 customers after putting in place new affordability checks.
The company, which has faced criticism for its high interest rates and debt collection tactics, made the changes after discussions with regulators.
Customers in arrears whose loans would not have been made under the new checks will have their debts written off.
A further 45,000 customers in arrears will not have to pay interest on loans.
Affected Wonga customers will be notified by 10 October.
Wonga's chairman Andy Haste, who joined the company in July, said a review of lending practices had shown the need for change at Wonga was "real and urgent", and new stricter lending criteria would mean "accepting far fewer applications from new and existing customers".
Analysis: Jonty Bloom, business correspondent, BBC News
Pay day lenders first appeared in the US, but are only legal in 27 states and interest rates are generally limited to 40%. They began appearing in the UK 20 years ago, and there are currently no limits on their charges here - although the government wants to bring in a cap next year.
Wonga itself is only seven years old but has become the best known thanks in part to its catchy advertising.
All pay day lenders normally lend to those not welcome elsewhere, because their poor credit rating or low income means mainstream lenders see them as unlikely to repay any loan.
Since the downturn their business has expanded rapidly, leading to criticism they are making millions lending to the desperate. Some say they are little more than legalised loan sharks, but supporters say if they did not exist, hard-pressed people would have to borrow from real loan sharks.
"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," he said.
"I agreed with the concerns expressed by the FCA and as a consequence of our discussions we have committed to taking these actions."
'Industry on notice'
In a statement, the FCA said Wonga's changes were as a result of a "voluntary agreement" reached between the lender and regulator.
"This should put the rest of the industry on notice," said Clive Adamson, director of supervision at the FCA. "They need to lend affordably and responsibly."
Wonga has also been told it must appoint a "skilled person" to monitor its lending decisions and report back to the FCA.
One Wonga customer from South Yorkshire told the BBC that Wonga's credit checks had been "poor at best".
"I'm currently in arrears of £564 with Wonga for a loan that started in 2012. I got caught up in the whirlwind of being able to have money deposited in your account within minutes.
"I was allowed to exaggerate my income on the application forms. They weren't checked to be sure that I wasn't giving false information. I should never have been lent the money."
Wonga currently provides lending services to about one million customers a year.
But it and the wider payday loan industry have attracted controversy because of the relatively high rates of interest charged to customers, which can quickly escalate if repayments are not made on time.
In June, Wonga also admitted sending customers in arrears fake letters from non-existent law firms in an apparent attempt to scare them into repayments, and agreed to pay £2.6m in compensation.
The move to tighten up lending criteria is likely to hit Wonga's earnings. Earlier this week, it announced a 53% fall in annual profits and said it expected to be "smaller and less profitable" in future, partly as a result of new controls set by the FCA.
Business model questioned
Michael Ruck, senior associate at Pinsent Masons and a former FCA lawyer, said Wonga will now be required to get more information on potential customers before making loans - an expensive process.
He said the whole landscape for payday loan companies was changing dramatically.
"It certainly raises questions of Wonga and other firms about how they set up their business models going forward," Mr Ruck told the BBC.
"They are clearly no longer going to be able to rely on revenues from customers paying high rates of interest without fully understanding the implications.
"In terms of other firms they are being told that: 'If you don't get this right, this is what is going to happen'."
The debt charity StepChange welcomed Wonga's move, but said it needed to be part of a "comprehensive reform of the short-term credit market".
"People will always need to borrow, and we need responsible lenders to allow this to happen in a fair environment," chief executive Mike O'Connor said.
Case study: 'I lied to get a £120 Wonga loan for a holiday'
When Elliott Gomme needed money for a holiday, he turned to payday lender Wonga.
He needed £120 and says he didn't have a problem convincing them to lend him cash by saying he worked full-time.
But the 20-year-old admitted lying on his application and told BBC Newsbeat it was "too easy" to be accepted.
He's now likely to be one of 330,000 people whose debts will be written off after a ruling that Wonga lent money to people who couldn't repay it.
"My bank couldn't give me an overdraft or anything, and so I went to [Wonga]," he says.
He received his money and went on holiday, but a few weeks later he says the firm started calling him and he says they were "constant".
"They were ringing me every day," he says. "They were telling me how much I owe and that there was added interest."
Elliot says that a few months later he was being told his debt had risen to more then £800 and it began to affect his day-to-day life.
He says the amount of the debt was making him feel depressed and that he had "no idea" what he would have done if this ruling hadn't come.
In Elliott's opinion, the whole process is too simple and he wants payday lending to be banned.
"It's so easy to go online and get one that you don't really look at the small print and they don't really tell you that much," he says.