Williams, a former skipper at Saudi Arabian club Al Qadisiyah and England's Middlesbrough, was the standout candidate to fill the role left vacant with the departure of Dylan McGowan in July.
Capped 14 times by the Socceroos, Williams is a new arrival at the Wanderers but has a 14-year professional career behind him.
"Since arriving at the club, Rhys has been a fantastic leader and individual in our pre-season preparations," Wanderers chief executive John Tsatsimas said.
"Rhys has led the group with pride, respect and honour and we look forward to him and the team having all the success this season."
Williams, 32, is one of several new faces at the club as coach Carl Robinson attempts to get the Wanderers back in the finals for the first time since 2017.
The Welsh coach was hopeful Williams' experience would play a big part in the Wanderers achieving their goals this season.
"He is the epitome of a good teammate and leader, he is very vocal but detail orientated in his communication," Robinson said.
"He also supports the young players that we are trying to develop here at the Wanderers and has the respect of our key senior players."
Williams is an A-League championship winner, having been part of Melbourne Victory's triumphant squad in 2018.
He said the chance to lead the Wanderers was a highlight of his lengthy career.
"Having only been at the club for a few months, it feels like I have been here for years and I feel at home at the Wanderers," he said.
"This is a major milestone in my professional career and I hope to make not only my family, but the people of Western Sydney proud."
The Wanderers begin their 2021-22 season against cross-town rivals Sydney FC at Commbank Stadium on November 20.
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