Prime Minister Manmohan Singh will hold additional charge as finance minister.
Chidambaram replaces Shivraj Patil, who resigned on Sunday, owning up responsibility for the Mumbai terror attacks.
Congress sources said Chidambaram is a man who can plan strategy and execute it in time of crisis. A Congress source told rediff.com,"We understand that India has the sympathy of the people and governments all over world."
Chidambaram was minister of state for internal security in the Rajiv Gandhi government, at the height of the Punjab crisis.
Dr Singh was finance minister in the P V Narasimha Rao government.
PTI adds: Indications that Chidambaram would be given the new responsibility came when he was called as a special invitee to the Congress Working Committee on Saturday night. He met the prime minister on Sunday morning to discuss the situation arising out of the Mumbai terror attacks.
After recommending Patil's resignation to President Pratibha Patil, who is away in Indonesia, Dr Singh spoke to Chidambaram formally conveying the decision to give him the new assignment.
Shortly after his appointment, Home Secretary Madhukar Gupta briefed him on the ministry, especially in the current context of tackling the menace of terrorism.
Chidambaram started his ministerial career as a deputy minister of personnel and training in 1985 and was promoted as minister of state within a quick time.
He was the minister of state for commerce with independent charge in the Narasimha Rao government.
He later held the finance portfolio in the United Front governments headed by H D Deve Gowda and I K Gujral -- he left the Congress briefly to join the Tamil Maanila Congress -- a ministry he got again when the Congress-led United Progressive Alliance came to power in 2004.