According to BILD, the 39-year-old Spaniard will join the club from June and take over Marco Rose's place.
Rose will take over for Dortmund at the end of the season.
Another footballing legend takes a major managerial role
Xabi's two-year contract with Real Sociedad where he currently coaches the club's reserve B side is to expire at the end of the season.
The agreement with Gladbach means Xabi takes over a team that's already competed in the Champions League this season.
Gladbach also drew attention recently for ordering U-23 coach Heiko Vogel to train the women's team as punishment for misconduct.