The issue of how to reduce moral hazard when failing banks receive government support has been a hot-button issue for David Murray's inquiry. Ending the perception of "too big to fail" is also a key agenda item for the Brisbane G20 leaders summit in November.

COBA's submission attached analysis from modelling firm Macroeconomics quantifying the annual average value of the subsidy to the big four from being seen as too big to fail as between $2.9 billion and $4.5 billion, as funding costs were reduced by between 22 and 34 basis points. A separate submission by the regional banks quantified the subsidy at about $2 billion a year, using IMF assumptions.

"Major banks already have a significant cost of funding advantage over smaller competitors due to factors such as their size, asset base and risk-management capacity. The additional funding cost advantage of an implicit guarantee provided at no cost by Australian taxpayers gives the major banks an even more powerful market position," said COBA, which represents nearly 100 credit unions, reaffirming calls for a levy on the big banks to "ameliorate their unfair and harmful funding cost advantage".

The regional banks submission, made by Bendigo and Adelaide Bank, Bank of Queensland, ME Bank and Suncorp Bank, said an increase in capital charges on the big banks would be "a more direct means of addressing the funding cost gap".

The Australian Prudential Regulation Authority has set a levy of 1 per cent for the big four after designating them domestic systemically important institutions (D-SIBs). The regional banks said this should be higher, "at a level that eliminates the funding advantage brought about by the 2 notch upgrade".

COBA also supports an increase to the D-SIB capital surcharge and said big banks' arguments that higher capital will increase funding costs should be treated with caution. "We note that higher regulatory capital does not automatically mean higher funding costs. It is argued that because increasing regulatory capital makes an institution safer, the institution's overall cost of funding including debt funding should fall."

Second-round submissions also addressed funding of the Financial Claims Scheme, which guarantees retail deposits up to $250,000. The Australian Bankers Association said the scheme should continue to be paid for by the recovery of assets after an institution failed, but the Reserve Bank wants the scheme to switch to an upfront fee, which is now common internationally and "is in line with the principle of users paying for the benefit provided".

With David Murray telling The Australian Financial Review earlier this month he is inclined to support a "ring-fencing" law to separate banks' trading arms from lending and deposits, the banks and the central bank both said the existing regime of vigorous supervision by the Australian Prudential Regulation Authority was a preferable option. Arguing against a ring-fence, the Reserve said the inquiry needed to look at "the fact that trading books comprise a small portion of Australia's large banks' balance sheets, so there is less scope for large trading losses to 'spill over' and affect the provision of credit in the economy". The Australian Bankers Association said ring-fencing was "both inefficient and inappropriate".

And ahead of the G20 meeting that will arrangements for the cross-border resolution of failing institutions, the Reserve said: "The appropriate resolution strategy for a failed institution depends on the circumstances. Accordingly, it is helpful to have a range of potential resolution tools available, a point often emphasised in current international deliberations on this issue."