The State Government has brought forward the expansion of Ravenhall prison, in Melbourne's west.
It was initially announced as a 500 bed facility with room for expansion.
Now the medium security facility will be expanded to accommodate 1,000 prisoners when completed in 2017.
Prison insiders have told that tensions were rising because the system was stretched to the limit.
Some inmates were being forced to sleep on in the communal areas of seven medium security jails in Victoria to cope with overcrowding.
Premier Denis Napthine says the new prison will be one of the biggest in the country.
"We need to make our community safe, we need to have a law and order system that is effective, fair and reasonable," he said.
"That law and order system requires adequate prison beds.
"Ravenhall will be on par with the biggest correctional facilities in the country."
Corrections Minister Ed O'Donohue says that increasing prisoner numbers had placed significant pressure on the operation of Victorian prisons.
"This is the prison that Labor was told three times to build and three times refused to build," he said.
Construction on the prison will begin in 2015 and will be completed late in 2017.