"Unknown people planted explosives in a plastic bag," said a police officer who declined to be identified as he is not authorised to speak to media.
Peshawar police chief Mohammad Ali Gandapur told Reuters the bomb contained up to 6 kg of explosives.
Though militant violence in the city, and in Pakistan in general, has fallen over recent years, there has been an increase in attacks on the security forces this year in Khyber Pakhtunkhwa province, of which Peshawar is capital.
Some of the past attacks have been claimed by the Pakistani Taliban. However, the militant group released a statement saying they condemned Tuesday's blast and denied involvement.
Prime Minister Imran Khan on Twitter sent his condolences to family members of the victims and the injured. "I want to assure my nation we will ensure the terrorists responsible for this cowardly barbaric attack are brought to justice ASAP," he said.
Tariq Burki, director the city's Lady Reading Hospital, said earlier that four of the seven dead were children but later said four children were wounded and all the dead were adults.
Five of the 83 wounded were in critical condition, he said.
The hospital released a list showing more than a dozen of those wounded were from Afghanistan.
A video shared by police showed the madrassa's religious scholar Sheikh Rahimullah addressing students, citing religious texts on the importance of education when a huge blast ripped through the hall, knocking over the camera.
A hospital source said he had survived the blast but was receiving treatment in hospital.
Photos provided by police depicting the aftermath showed debris strewn around the hall and a small crater.
The madrassa is largely for adult students and many were studying when the blast happened, said city resident Abdul Rahim, whose said his 27-year old cousin was among the wounded.
"He told us they were attending a class when the blast took place," Rahim said.
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