"This will bring our laws into the 21st century."
Human rights groups complained that the sponsorship system was open to exploitation, citing instances of employers withholding pay and holding onto workers' passports.
Abdulla Al Derazi, the secretary-general of the Bahrain Human Rights Society, told Al Jazeera on Thursday that he welcomed the decision, calling it a "courageous step".
"This is something that the Human Rights Society in Bahrain has been asking and pushing for because [the sponsorship system] contradicts international conventions for human rights," he said.
"It will make a big difference. This will help migrant labourers to have more opportunities of better work, rather than to be restricted by one sponsor who will control them all the time."
Under the new system, the government will take over responsibility for providing expatriate employees with work permits issued for renewable periods of two years, Al Ahmed Randhi, the chief executive of Bahrain's labour market regulatory authority, told the AFP news agency.
Randhi said the system would help Bahrain "conform to international regulations and human rights norms" .
He said it would also allow greater flexibility in matching the migrant workforce to the country's economic needs.
Foreigners make up about half of Bahrain's population of just more than one million people.
Many low-wage jobs in oil-rich Gulf nations are filled by expatriate workers, whose residency permits are often linked to a sponsoring employer.
Bahrain will become the first Gulf Arab nation to end the sponsorship system once the new rule takes effect in August.