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MPs today have set out plans to stop a another Northern Rock happening and protecting savers' cash – hitting out at government proposals and saying if a bank collapses customers' cash must be returned in seven days.

The parliament Treasury committee has issued a report on banking reforms needed claiming the current compensation system for savers – under the Financial Services Compensation Scheme (FSCS) - does not work after the government's consultation on legislation for the future of banking closed yesterday.

John McFall, committee chairman, hit out at the current plans saying the government was muddled and not placing the consumer at the heart of legislation.

"There has been much focus on whether the appropriate compensation limit should be £35,000, £50,000 or £100,000,” he said.

“This is irrelevant if we do not possess a deposit protection system that actually works. It is far more important that banks be able to identify who their insured depositors are, and that the FSCS be able to process compensation claims quickly.

“The overarching priority for the FSCS must be to design a simple and confidence-boosting scheme, which does not rely on consumers having an unrealistic knowledge of banking licences, European directives and foreign compensation schemes."  

The committee is also calling for the Bank of England to have have a greater role in maintaining financial stability, with any body to oversee banks having the same status as the interest rate-setting monetary policy committee (MPC).

McFall said: "The government's proposals for the new Financial Stability Committee of the Bank of England are confused - the Northern Rock fiasco taught us that clear lines of responsibility are important.”

The Treasury committee is also calling the regulator the Financial Services Authority (FSA) to have sole authority on pulling the trigger for any rescue needed for a failing bank.

Yesterday the Association of British Insurers (ABI) responded to the government consultation saying it would hit investors in banks and make it harder for financial firms to raise capital – as the government could more easily take over banks and push cash to savers over investors.

New rules for protecting UK banking will be introduced in February, when temporary legislation brought in when Northern Rock's near collapse expires.