Its investigation hinges on PayPal's reporting of funds transferred in and out of the country.

AUSTRAC chief executive Nicole Rose said businesses like PayPal played a critical role in stopping the movement of money to pedophiles and terrorists.

"PayPal is an important partner in the fight against crime," Ms Rose said on Tuesday.

"However, when we suspect non-compliance AUSTRAC will take action to protect the Australian community."

Any possible breaches could result in fines, compliance actions or criminal prosecutions.

Opposition Leader Anthony Albanese welcomed the investigation.

"What we should do is listen to the appropriate regulators to make sure that no private sector organisation can escape scrutiny," he told reporters in Bendigo.

"It's a matter of appropriate regulation. Specific examples of allegations of abuse of market power should be investigated and there should be a response to that."

PayPal said it was fully committed to complying with Australian laws.

"Following an internal review, our business in Australia self-disclosed an issue in our reporting system for International Fund Transfer Instructions to AUSTRAC," a company spokesperson told AAP.

"We are working in full co-operation with AUSTRAC to remediate this reporting system issue and to undertake the audit as outlined by AUSTRAC in the time specified.

"There is no impact to our customers, who can continue to use PayPal services as usual."

The external auditor will report back to AUSTRAC within four months.

PayPal will be forced to cover the costs of the audit.

Australian Associated Press