Prime Minister Malcolm Turnbull announced the signing of the memorandum of understanding in which Association of Southeast Asian Nations (ASEAN) agreed to share intelligence, co-operate on lawmaking and counter extremism on social media.
Australia is hosting ASEAN meetings this weekend, despite not being a member of the 10-nation bloc, as it seeks to tighten political and trade ties in the region amid China's rising influence.
Turnbull said in a televised address to ASEAN that Islamic State's influence was growing in Southeast Asia after the militants had lost their caliphate in the Middle East.
"They'll return battle-hardened and trained, so it's vital for Australia and our ASEAN partners to collaborate across borders," he said.
Turnbull said non-conventional tools such as digital currencies, stored value cards and crowd-funding platforms were making it harder to detect terror financing.
"As regional partners, we all play a crucial role in combating these disturbing and dangerous phenomena," he said.
Australian Home Affairs Minister Peter Dutton said the government would introduce a new law to crack encryption online. The new law would force companies providing communications services and devices in Australia to help agencies in investigations, he said in a press release.
Malaysian President Najib Razak said Islamic State's online propaganda could reach more than 300 million Muslims in Southeast Asia.
"What is also very important is promoting a culture in which radical ideologies find it hard to take root," he said.