Businessman Sean Quinn's exposure to Anglo Irish Bank could have affected the stability of the whole financial system, the Banking Inquiry has been told.
Former Central Bank director general Tony Grimes said the bank was aware of the risk from early 2008.
Mr Grimes said the Quinn Group issue was discussed "in general terms" at a meeting in July 2008, but it was his understanding that the Central Bank was aware "a month or two earlier".
He confirmed to Fianna Fáil Deputy Michael McGrath that he felt it was "highly unusual" that Anglo was funding margin calls for Mr Quinn when he was one of the biggest investors in the bank.
Mr Grimes agreed that it was "a big issue". At that meeting the problems at Anglo were raised in general terms of the difficulties caused by 'contracts for difference', the need to unwind them and the risks if shares were suddenly released to the market.
He also stressed that while the Central Bank would have been concerned about the possible implications for shareholders and liquidity, it regarded the issue as a regulatory one.
Mr Grimes described how the outflows of corporate deposits at Anglo in the two weeks from mid-September were particularly severe and "regarded as unsustainable".
"The system could not continue on this basis without the banking system imploding," he said.
Mr Grimes denied to Socialist TD Joe Higgins that three days before the bank guarantee it was known at the highest level politically and financially that two banks were insolvent.
The Financial Regulator had told an informal meeting with the Taoiseach, Central Bank and National Treasury Management Agency on September 26, 2008 that two banks were not insolvent but "illiquid".
According to Mr Grimes, a Department of Finance official said one bank had a €2bn hole and another had one of €8.5bn, but no one left the meeting thinking the banks were insolvent.
Con Horan, former prudential director of the Irish Financial Services Regulatory Authority (IFSRA), said he was the exception to all the regulators who had failed.
It was known within the Central Bank that he held views "contrary to the group-think on property lending that existed in the Central Bank and Financial Services Authority of Ireland".
When he took up office he introduced stringent measures to curb high loan-to-value mortgages, but he regretted that these were introduced too late to prevent the crisis.
"This is a matter of deep regret. The system afforded far too much scope to the banks and placed too much faith in the boards and management and their control systems for risk management, internal audit and compliance," he added.
The inquiry also heard yesterday that the Financial Regulator did not have enough staff.
Mary Burke, who headed up the supervision division of the IFSRA, said: "I'm crystal clear here, we did not have the resources to supervise these banks."
She said that her section had a three-person team responsible for Bank of Ireland and Anglo Irish Bank, a three-person team for AIB and Irish Life and Permanent and a four-person team responsible for eight credit unions and a branch including Irish Nationwide Building Society and the Educational Building Society.
A request for six extra staff "was effectively refused" in May 2008.