"The Federal Council wants to ban from Switzerland companies offering mercenary services," the government said in a statement on Wednesday.
"The new law would make it illegal for security companies based in Switzerland to directly participate in hostilities within the context of an armed conflict abroad," it added.
In the proposed law, which will need parliamentary approval before it can take effect, all companies headquartered in Switzerland would be required to declare all their security-linked activities abroad, the government said.
This would allow Swiss authorities to determine whether the activities fell within the law or whether they should be banned, it said.
The new rule would apply not only to companies which offer security services in Switzerland and abroad but also holding structures of firms that only do their business overseas.
"Security companies will not be permitted to carry out activities susceptible to enabling serious human rights violations," the government said, adding that firms would for instance be blocked from running prisons in countries known to use torture.
The Swiss government had said it was necessary to regulate private security firms after Britain's Aegis Group Holdings, one of the world's biggest security companies operating in crisis or conflict zones, moved its headquarters to Basel in 2010.
Around 20 security companies in Switzerland offer similar services.
It will likely take another two to three years before the new law passes through both houses of the Swiss parliament, and it could take another year or so after that before it goes into effect, government spokesman Luzius Mader told AFP.
"This won't happen overnight," he said.