Reserve Bank governor Glenn Stevens is warning the federal government its guarantee of bank deposits must be changed.
The government ignored the RBA's concerns about the impact of an unlimited guarantee scheme for all Australian deposit-taking institutions from October 12.
The RBA says that decision is creating serious dislocation in the financial system, The Australian reports.
Several investment bank heads wrote to the government on Friday warning their exclusion from the scheme was damaging their ability to lend to the corporate and mortgage market in Australia.
The government is belatedly considering the introduction of a new deposit cap of $5 million.
But Mr Stevens informed Treasury Secretary Ken Henry on Friday that the lower the cap set, the better.
The newspaper says the main problem is short-term money is rushing out of any institution, security or cash management account that is not guaranteed and is being put into deposits that are.
In many cases the deposits are made by large institutional investors and worth millions of dollars.
The government sought to protect small retail depositors, but the RBA wants the government to introduce a dollar cap to the guarantee.
The RBA argues the current version of the guarantee is completely distorting the market, particularly the short-term money market.
It says the government risks making it harder rather than easier for Australian companies to raise funds.