The problem is that it was too much like a prison. Ideally, Mages should be taught to have the will to resist demons. They should be trained in that and trained to use their abilities to help them fight demons. After they pass that test (the one you do in the beginning of DAO as a mage) or maybe even before it, they should face off against demons. There seem to be enough of them. They should be trained to deal with them and see them and understand that this is the result. They need to see this to scare the wits out of them so they don't do blood magic.
The templars should be different as well. First, we know they don't need lyrium. Alistair proved that. So no more lyrium for them. Mages at some point should work side by side WITH templars. Templars should be the GUARDIANS of the mages not the forces that stand against them. They should understand that while there are blood mages, in part some do it out of curiosity or not really believing the dangers so they need to see the dangers which is why working together is important. It was the rare mage that saw abominations that was cool with it. It was as if they really didn't believe it could happen. Look at how the tower was in DAO. Mages were terrified and some had gone along with it but had no clue of the possible outcome. So it was like they were taught something the way a parent teaches a child something to scare the child but the child doesn't always believe it or they might at first but later view it as a lie. This is how it seemed to mages. Perfect example is Jowan. He really had no clue of the dangers. That's the impression I got. Mages need to see abominations and to fight them with templars and templars should be charged with teaching them this and working together with them as eventual allies. Templars should be guardians of mages. Mages are their charges. A few are bad but mostly they need to learn how to protect themselves because they are at risk due to their naivety, stubbornness, and general ignorance about the facts. They need to be treated as equals to not become steadfast in their naivety, stubbornness, and ignorance. They need to see what really happens. It should be a Templars duty to work WITH the mages to help them see what the reality is. I believe few mages would be willing to risk blood magic if they were sent along side of templars to hunt down abominations that were the result of blood magic. This is how the templars would be of most benefit, in prevention rather than clean up. There should be two types of templars though all should be trained in all aspects. One side would be the ones that are hunting blood mages and abomination and the other side should b those who are charged with protection and teaching mages to use their will as a form of protection the way templars do. Templars should have to serve as both but start as guardians so they don't begin with hatred for the mages. No templar should be hunting abominations constantly. They should rotate them so that only a short portion of their time as a templar would be in hunting mages and guardian templars should be called in as needed for support to aid the 'shock troops' so they will stay skilled at that and not become complacent as well as to minimize the need for a larger force of templars working as shock troops at any given time.
The whole system becomes utterly fracked the minute it's them/us. It needs to be US across the board. An alliance of sorts where mages learn quickly why this is needed during their formative years. After that, they have more liberties and freedoms so it's less restrictive but still some sort of basic oversight.
Probably too ideal but what they have now is just a mess pitting two factions against each other - one with power, the other not. That never works well except in a TRUE prison and even then, not always. If Cullen of all people can modify his views to not hate mages and work with them as necessary then anyone can (except perhaps the most narrow minded who would be unfit to be templars and should never be allowed to be templars).