The civil action will be launched in the Federal Court on Tuesday and involves 229 Westpac customers impacted by the bank's online hardship notice process.
The Australian Securities and Investments Commission alleges that between 2015 and 2022 the customers did not receive a response to their hardship notices within the required 21 days.
"Submitting a hardship notice, which results in a change to the credit contract, can be a lifeline for people experiencing challenging financial circumstances," ASIC deputy chair Sarah Court said in a statement.
ASIC said it was taking legal action to highlight the importance of lenders responding to hardship notices within the required time frame to reduce harm to their customers.
"Westpac's failures to respond to these notices compounded their customers' difficult financial circumstances," Ms Court said.
Under the National Credit Code, a lender has 21 days to notify a customer signalling hardship if it does not agree to change the contract or if it requires further information to make its decision.
ASIC also claims Westpac didn't do enough to investigate and rectify systems issues affecting its online hardship notification process.
Westpac said the technology failure happened as the bank received about 630,000 applications for hardship assistance between 2015 and 2022.
"This error meant we didn't provide some of our customers with the help they needed," Westpac group chief information officer Scott Collary said.
"For this, we are deeply sorry."
Mr Collary also said Westpac had contacted the affected customers as part of a $900,000 remediation program that included refunds of fees and interest, debt waivers and payments for non-financial loss.
Westpac also noted it had self-reported the incident to the regulator.
The date for the first case management hearing is yet to be scheduled.
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