Bangladesh President Zillur Rahman made the new law through a presidential decree, vesting the government-picked chairman of the bank with the ability to select a new managing director to take over from founder Muhammad Yunus.
According to the law, seen by AFP, the chairman of the bank will constitute a selection committee to find a new managing director, rather than its 12-member board, which includes nine women directors who are also borrowers.
The move comes despite criticism both at home and abroad that the government is seeking to undermine the independence of the bank, the majority of which is owned by more than eight million poor women borrowers.
The United States has voiced deep concern about the state's expanding role.
Mr Yunus, the 2006 Nobel Prize winner who was ousted from the bank last year, has accused the government of trying to "destroy" the lender.
The chairman-appointed selection committee will pick three candidates for the top job, one of whom will be chosen by the full 12-member board.
Critics worry that only pro-government candidates will make it through the selection process.
Mr Yunus, who fell out with Prime Minister Sheikh Hasina after talking about going into politics, was officially fired last year for exceeding the mandatory retirement age of 60. He challenged the move in the Supreme Court, but lost.
Law Minister Shafique Ahmed says the new law would make the recruitment process "transparent and acceptable".
Finance minister A.M.A Muhith rejected criticism that the move would lead to a government takeover of the bank.
In a statement earlier this month, Mr Yunus said the government planned to curb the power of the bank's poor borrowers, who are also its owners, after the cabinet approved the move to increase the power of the chairman.
"Now my fears are becoming true. With these changes the poor are going to be deprived of their ownership of the bank. I am very hurt with the decision. I am so shocked that I cannot express my emotion," he said at the time.