Australia will guarantee Nauru's access to banking services in exchange for an effective veto power on the Pacific nation entering security agreements with other countries.
The two countries will have to agree to any engagement in Nauru's security, banking and telecommunications sectors and consult on outside engagement in other critical infrastructure.
While it is yet to be seen how the mutual security clause might work in action, the wording suggests Australia has to sign off on any external agreements or use of Nauru's critical infrastructure for security purposes by another country.
It essentially locks China out of a policing agreement as Australia pushes back against Beijing's moves to gain a security foothold in the region after it signed a pact with the Solomon Islands.
In exchange, Australia will provide $100 million for Nauru's budget and $40 million for policing and security, both over five years.
Commonwealth Bank will provide banking services in the small island nation from 2025 after Bendigo Bank departs.
The federal government is not paying the bank to service Nauru.
Australia has been working with major banks to keep a Pacific presence amid fears China could use any vacuum to ingrain itself in regional financial services.
Australia wanted to minimise the risk of Pacific island countries becoming dependent on Beijing in any sector, China expert Ben Herscovitch said.
Any dependency could be leveraged by China to exert influence on Pacific governments and financial services could lead to elite capture "where leaders are more amenable to doing Beijing's bidding", Dr Herscovitch told AAP.
Bank of China had expressed interest in expanding its services to Nauru.
Pacific expert Meg Keen said budget and banking services were critical issues for Nauru but the support came at a cost.
"Australia is moving to cement itself as the primary development and security partner in Nauru," Dr Keen said.
"In the end, it's a sovereign country, it was in a difficult situation and it has taken the best deal on the table.
"There has been an element of a sovereignty sacrifice to gain greater economic and financial security."
The Nauru-Australia treaty was in the best interests of both countries, Prime Minister Anthony Albanese said.
"The treaty also reflects our shared commitment to Pacific-led security," he told a joint press conference in Canberra on Monday after the agreement was signed.
"This is a good day for Australia, this is a good day for Nauru and it is a good day for the security and resilience of the Pacific region."
Nauru was the Pacific's most vulnerable nation, President David Adeang said as he welcomed Australia's backing.
"We appreciate Australia's steadfast support as we try to address our unique development challenges," he said.
The treaty will come into force in 2025 after Australia ratifies it after Nauru's cabinet already gave it the green light.
There is a 12-month notice period if either side wants to exit the pact.
