LAST Monday, Ireland's banking crisis shifted gear. In the unassuming setting of a District Court, the Garda Fraud Squad sought and was granted permission to search three offices of Anglo Irish Bank.

The next morning a team of 16 garda officers joined members of the Office of the Director of Corporate Enforcement to raid the bank. There was no 'perp walk' -- uniformed gardai did not drag bankers from their offices and march them, handcuffed, towards a fleet of prison vans -- but the significance of the move could not be understated. For the first time since the Government was forced to ride to the rescue of all the Irish banks on September 29 last year, the gardai had stepped inside a bank to search for evidence of a crime.

The drama of the garda raid and the steady drip feed of scandal that has flowed from Anglo in the past few months has dominated the headlines and has helped assuage some public anger, but it has masked an ever greater crisis that has been bubbling up beneath Ireland's two major banks.

Both AIB and Bank of Ireland have seen their share prices devastated this year as investors flee the Irish market -- on Friday, Bank of Ireland closed at 19c, with AIB at 39c -- and both banks must try to convince international markets to lend to them.

Last week, the Government took the plaudits for its ability to raise €4bn in the markets, albeit at a high price relative to the rest of Europe.

This year, Ireland's banks need to raise 20 times that amount to roll over their existing liabilities, and liquidity is drying up fast.

The problem the banks face is compounded rather than eased by the Government's blanket guarantee on their debts and deposits. "The markets no longer judge AIB and Bank of Ireland on their individual merits," says one trader. "They are now lumped together with Ireland Inc, and judged on a par with the Government. That's not good, because many institutions have made a simple decision about Ireland: do not invest."

The Government's loss of credibility on the markets, which has been fed by its failure to devise a comprehensive plan that cuts spending and charts a course, however sketchy, to economic recovery is now damaging the very institutions that its guarantee was meant to protect.

Criminality and national collapse were not on the agenda in September when Brian Cowen, the Taoiseach, and Brian Lenihan, the Minister for Finance, were briefed on the potential meltdown of the Irish banking sector by their most senior advisers.

It had been a nerve-shredding day on the stock market, with Irish bank shares sold aggressively and Anglo tumbling by almost 50 per cent in value. If the carnage had continued the next day -- which was likely -- Anglo would have collapsed.

The falling share prices did not matter in themselves, but they reflected an evaporation of investor confidence that had already been replicated in the deposit market, with billions of euros flowing out of Irish accounts as businesses and individuals sought safer havens for their cash.

If that flight accelerated, it could kill a bank. Cowen and Lenihan were warned that if Anglo died the rest could follow "within minutes" -- causing an economic crash of cataclysmic proportions.

The sense of crisis deepened when news came through that the US House of Representatives had voted down the Bush Administration's $700bn bail-out package -- a vote that drove Wall Street lower and which would ensure another bloody day on the stock markets in Europe the next morning. The gloom was compounded by the arrival of the chief executives and chairmen of AIB and Bank of Ireland, forecasting disaster for Anglo and begging the Government to intervene.

The banks' agenda was clear-cut: they wanted the Government to nationalise Anglo Irish overnight and prevent its contagion spreading to them. At the time, both AIB and Bank of Ireland believed themselves to be robust and did not fear for their own future -- so long as Anglo could be prevented from implosion.

Lenihan and Cowen knew that Anglo's situation was critical. They knew that liquidity was a serious issue for Anglo, and they knew there had been depositor flight. That day, both Bank of Ireland and AIB had been asked by the Government to each make €5bn available to Anglo the next morning, and both had only agreed once they had extracted explicit Government guarantees for the money.

Both had resisted entreaties in the previous weeks to lend Anglo money -- Bank of Ireland had been asked for €2bn, but declined -- but with a guarantee on the table, they changed their minds and reluctantly agreed.

Lenihan and Cowen knew that Anglo was on the brink, and Lenihan was almost persuaded that nationalisation that night was the right approach. Cowen, however, would not contemplate an approach that treated banks differently and vetoed nationalisation.

His fear, sources say, was that nationalisation would have sparked legal action from the bank and from its shareholders, and that the Government did not have the evidence necessary to justify nationalisation -- even if it suspected the worst.

The Government's options were limited. It could choose to let the markets have another run at the banks, and let the weakest fall, trusting that once they had been culled from the herd the others would gather strength. It could step in and nationalise the most vulnerable bank -- Anglo Irish -- and trust that the others would survive. It could selectively guarantee the stronger banks, and let the others die. Or it could guarantee all the banks, buy time and stability, and then move to sort out the mess in the breathing space that the guarantee might provide.

These were not decisions that Cowen and Lenihan, or their key officials -- including Paul Gallagher, the Attorney General, John Hurley, the governor of the Central Bank and Patrick Neary, the Financial Regulator -- were accustomed to making. They were outside their comfort zones, trying to cope with an unfolding drama that had no recognisable script. These were dark international forces, or so it seemed at the time; irrational, dangerous and unconnected from domestic reality. They had to act, but they had no way of understanding how their actions would be interpreted.

At close to midnight the four bank directors -- Brian Goggin and Richard Burrows of Bank of Ireland and Eugene Sheehy and Dermot Gleeson from AIB -- were told that the Government would guarantee the deposits and inter-bank borrowings of all the banks. It was a solution that had not been on the banks' agenda, but at least it was a solution of sorts. The crisis, they felt, was not over, but they had stopped the rot.

The next morning, the markets seemed to agree, and the banks' share prices climbed sharply on the back of the guarantee, which was hailed by many as a brave and innovative response to imminent disaster. There were rumblings from the European Commission and angry words from Alastair Darling, the British Chancellor of the Exchequer, but Cowen and Lenihan stood firm.

Their first duty, they said, was to protect Irish banks -- a response that prompted the Financial Times to describe their stance as "economic nationalism". Other British commentators were outraged by what they saw as a 'beggar thy neighbour' strategy which would encourage depositors to flock to Irish banks and desert British banks.

By the end of the day AIB's shares traded at 590c, Bank of Ireland at 395c and Anglo at 384c.

The €10bn secured by AIB and Bank of Ireland for Anglo's use was no longer required, as the guarantee had freed up liquidity, for the moment at least. Unknown to both, Irish Life and Permanent was also depositing billions with Anglo to cover some of its deposit losses.

Since that day, notwithstanding a Government guarantee that should provide confidence to all depositors and lenders, the two biggest Irish banks have seen their value shredded and Anglo Irish has been nationalised.

The scale of their collapse in value since that September rescue is breathtaking, even though the Government is ploughing €7bn of taxpayers' money into them, and even though both believe that they will be able to absorb their losses from bad property loans. The direct reason for the sagging share price is the fear that liquidity will dry up, but the indirect reason is Anglo Irish Bank. That is what the two banks feared on September 29, and those fears have come to pass.

When Sean FitzPatrick took over as chief executive in 1986, he was in charge of a financial minnow. It had a loan book of a few million and customers who borrowed £5,000. Over the next 18 years FitzPatrick turned it into the most dynamic bank on the European scene, with ever-soaring profits and an ever increasing balance sheet. It was FitzPatrick's success that played a large part in changing the culture at both AIB and Bank of Ireland, though the cultural shift sat more easily with AIB.

FitzPatrick was delivering dramatic profit growth every year and his established rivals were growing envious.

They faced pressure from their investors to match Anglo's growth so they, too, had started to expand their balance sheets. Mike Soden, who was appointed chief executive designate of Bank of Ireland in 2001, was, insiders say, hired with a remit to double the size of the bank

His failed bid for the Abbey National in 2002 was a sign of that strategy and by the time he was forced to resign in 2004 (because he had accessed soft-porn websites includ- ing www.squeezemytits.com) Bank of Ireland had been set on an ambitious growth path.

FitzPatrick had his rival bankers, and their shareholders, in thrall: he was an aggressive, dynamic, profit-making machine and they all looked feeble in comparison.

The unravelling of FitzPatrick started more than 18 months ago as the economy started to slow and the international banking crisis gathered momentum. By March last year, UBS, the Swiss bank, was advising its clients to sell Anglo shares because it felt that it was dangerously exposed to the slowing Irish market -- and by then Anglo's shares had already fallen 40 per cent from their peak.

It was then, too, that the problems of Sean Quinn's gamble on Anglo Irish shares started to cause FitzPatrick a major headache. Quinn built an effective stake of 25 per cent in the bank through the contracts for difference market. He would convert his CFDs into a 15 per cent stake, at a massive loss, but wanted to dump the remaining 10 per cent. Those shares, if released onto to the market, would have caused the Anglo share price to plummet, so FitzPatrick hatched his scheme to persuade 10 customers to buy the shares with the bank's own money.

The degree to which the Financial Regulator and the Department of Finance were aware of the arrangement are unclear, just as it is unclear precisely how complicit the authorities were in Irish Life and Permanent's multi-billion deposits with Anglo at the end of September.

That is what Paul Appleby, the director of Corporate Enforcement, must determine, and that is why a team of gardai raided Anglo's office last week. But there is plenty more for Appleby and the Financial Regulator to examine.

The September guarantee was designed to be a holding operation, with Lenihan promising that it would be followed swiftly by reform, reconstruction and, eventually, recapitalisation. Weeks passed, and nothing happened as the Budget intervened on October 14 and then the post-Budget demonstrations shook the Government and diverted attention. Lenihan did ask PricewaterhouseCoopers to conduct an independent audit of the banks, but progress was slow.

Anglo, AIB and Bank of Ireland slowly sagged in value, gyrating wildly on some days but with the course set firmly lower. Lenihan remained wedded to the concept of recapitalising all three of the main banks, rather than nationalising Anglo, and brought his proposals for recapitalisation into the public domain in December.

Anglo, he said, would get €1.5bn, the other banks slightly more in a mix of government and private capital. But as soon as he announced his plan, it was already unravelling amidst a rising stench of what FitzPatrick termed 'inappropriate' behaviour and which the market saw as fraud.

It was disclosed that FitzPatrick had hidden loans from Anglo shareholders by shifting them at each year end to Irish Nationwide, before switching them back to Anglo without his auditors noticing. Last year, he hid more than €80m from their eyes, aided and abetted by his friends at the Nationwide.

He resigned on December 18, along with Lar Bradshaw, another Anglo director. The next day David Drumm, the chief executive, resigned, followed by Willie McAteer, the finance director.

A month later, on January 15, Anglo Irish Bank was nationalised -- three and a half months after the two main banks had asked the Government to nationalise it, but had been turned down by Cowen.

The effect of that slow death has been devastating for the rest of the Irish stock market and for the two main banks. Where Anglo has been mired in allegations of criminality and corruption -- as yet unproven -- and faces months of investigation at the hands of regulators and gardai, AIB and Bank of Ireland stand accused of nothing criminal. Their faults are far more straightforward: poor lending policies, bad loans, economic downturn, management incompetence and a large dose of arrogance.

Casualties have been minimal -- Brian Goggin has taken early retirement from Bank of Ireland, replaced by internal candidate Riche Boucher, while AIB has refused to countenance any changes at the top of the bank. While both banks have damaged themselves, they have suffered massive reputational damage by association with a Government that has lost its own reputation. As Bloomberg, the international news agency, reported on its screens last week: "Ireland. Another day, another scandal".

Just five months after the Government handed out the most ambitious and unprecedented guarantee in the State's history, Bank of Ireland and AIB still have extreme difficulties. That guarantee, initially, caused the price of the Government's borrowing to rise on the market, but now it is the parlous state of the Government's finances, and its inability to announce a plan for recovery, that forces higher the price the banks must pay.

The gardai will trawl through the wreckage at Anglo, searching for clues and trying to piece together a complex criminal case. There are more revelations to come, and the trail of accountability will be pursued through the Regulator's office and into Government. That is as it should be, but the recriminations are a sideshow in a far greater tragedy.

The banking crisis has come full circle, with liquidity fears recreating the dramas of late September but now it is both the Government and the banks standing side by side facing a fearful and uncertain future.