The review, led by Lord Carlile of Berriew, found the inquiry into Bishop George Bell was too quick to accept the allegations of the complainant "without serious investigation or inquiry".
Claims made by a woman known only as "Carol" of abuse by Bishop Bell when she was aged between five and eight in the 1950s led the Church to issue an apology and pay £15,000 in compensation.
But the inquiry was widely criticised for failing to investigate the victim's claims or seek witnesses who had known or worked for Bishop Bell during his tenure as Bishop of Chichester between 1929 and 1958.
Bishop Bell passed away a few months after his retirement.
The inquiry led to the cancellation of a planned statue in Canterbury Cathedral celebrating the bishop's work helping to rescue Jewish children transported out of Germany during the Second World War.
Bishop Bell's name was also removed from a room at the University of Chichester, while a building in the town was also renamed.
Lambeth Palace commissioned a review of the original investigation following criticism from Bishop Bell's supporters that not enough was done to substantiate the complainant's allegations, and after no other alleged victims came forward despite a helpline being set up.
Lord Carlile emphasised that the review was not to establish the truth of Carol's claims, but only to investigate the Church's handling of the case and establish best practice for handling future complaints.
"I have concluded that the Church of England failed to institute or follow a procedure which respected the rights of both sides," he wrote.
"The Church, understandably concerned not to repeat the mistakes of the past when it had been too slow to recognise that abuse had been perpetrated by clergy and to recognise the pain and damage caused to victims, has in effect oversteered in this case.
"In other words, there was a rush to judgement."
He added the Church had "failed to engage in a process which would also give proper consideration to the rights of the Bishop" and that "such rights should not be treated as having been extinguished on death".
He said that by implicitly accepting a complainant's allegations as true without fully investigating, the Church risked a flood of allegations from "unscrupulous" complainants who viewed it as "a source of easy money".
Following the review's publication, Bishop Peter Hancock, the Church of England's lead safeguarding bishop, said: "At the heart of this case was a judgment, on the balance of probabilities, as to whether, in the event that her claim for compensation reached trial, a court would have concluded that Carol was abused by Bishop Bell.
"The Church decided to compensate Carol, to apologise and to be open about the case."
He added: "It is clear from the report, however, that our processes were deficient in a number of respects, in particular the process for seeking to establish what may have happened. For that we apologise.
"Lessons can and have been learnt about how we could have managed the process better."
The review found the Church acted in good faith and that it was right to acknowledge cases of sexual abuse committed by the clergy.
But it added: "That does not mean that the reputations of the dead are without value."
It recommended that during future inquiries: "In addition to someone advocating for the complainant, someone assigned to it to represent the interests of the accused person and his or her descendants."
Carol, now in her 70s, alleged that Bishop Bell would take her into his study and sit her on his lap to read to her before touching her intimately and inciting her to touch his genitals.
She said he would tell her "This is our little secret. It is God's wish", and that he was giving her "God's love ... you are special".
She also claimed he would say "Suffer little children to come unto me" while abusing her.
Carol had told someone that Bishop Bell was "interfering" with her at the time but had been accused of "telling fibs".
She did not make a complaint to the church until 1995, 37 years after her alleged abuser's death, but at the time was told to seek counselling.
The complainant did not pursue the allegation again until 2012 after several high-profile cases of historical sexual abuse by church figures had broken in Australia and the US, as well as the Jimmy Savile scandal.
The Church did not start investigating her claims until the following year.
Lord Carlile criticised the Church for failing to act promptly in 1995, but noted there had been "significant changes in procedure" in the last two decades.
He also noted that, despite the widespread publicity around the case, no complainant other than Carol has come forward.
Lord Carlile also spoke to a woman named only as "Pauline" who had been the adoptive daughter of the Bell family's housekeeper and had lived within the palace itself, but was never interviewed by the original investigation.
She described Bishop Bell as "schorlarly and dignified" and that he was "always kind to her".
Lord Carlile wrote: "It is at least very possible, and in my view likely, that Pauline's recollection broadly is correct. I tested her account, and found it compelling.
"This does not necessarily negate what Carol has said - and it is not my role to choose between them.
"Nevertheless, had the Core Group been aware of this evidence, they might well have approached their task differently.
"I consider that an inquiry into the facts by somebody with criminal investigative experience could well have found her, especially after a call for evidence."
Listen to Lord Carlile speaking with Premier's Tola Mbakwe here: