The shock announcement came a day after Lagarde was grilled for more than 15 hours by a special court in Paris that probes ministerial misconduct, the fourth time she has been questioned in a case that has long weighed upon her position as managing director of the International Monetary Fund.
"The investigating commission of the court of justice of the French Republic has decided to place me under formal investigation," she said in exclusive comments to AFP.
In France, being placed under formal investigation is the nearest equivalent to being charged, and happens when an examining magistrate has decided there is a case to be answered. It does not, however, always lead to a trial and cases are often dropped at a later date.
Asked whether she intended to resign from the IMF, she responded: "No." But her fate now hangs on what the IMF board of directors will decide.
"I have instructed my lawyer to appeal this decision which I consider totally without merit," said Lagarde, who replaced Dominique Strauss-Kahn as IMF chief in 2011 after he became embroiled in a New York sex scandal involving a hotel maid.
(Yes, You! The headline on the Lagarde story in Spain's Huffington Post)
"I return back to Washington where I will indeed brief my board," she added.
In an email to The Local IMF Communications Director Gerry Rice wrote: "The Managing Director has already made a statement on this matter.
"She is now on her way back to Washington and will, of course, brief the board as soon as possible. Until then, we have no further comment."
French government spokesman Stephane Le Foll was similarly tight-lipped, saying Paris "had no comment to make on choices that are down to the IMF and no comment on judicial decisions".
The case relates to her handling of a 400-million-euro ($527-million) state payout to disgraced French tycoon Bernard Tapie in 2008, which investigating judges suspect may have been doled out in return for his support of ex-president Nicolas Sarkozy in the 2007 election.
The payout to Tapie was connected to a dispute between the businessman and partly state-owned bank Credit Lyonnais over his 1993 sale of sportswear group Adidas.
Tapie claimed Credit Lyonnais had defrauded him by intentionally undervaluing Adidas at the time of the sale and that the state, as the bank's principal shareholder, should compensate him.
Lagarde referred the dispute to a three-member arbitration panel that ruled in favour of Tapie and ordered the payout, which included 45 million euros in moral damages.
Arbitration panel a 'sham'?
Investigating judges are seeking to determine whether the arbitration was a "sham" organised to reward Tapie for his support of Sarkozy.
The IMF chief has always denied having acted on the former president's orders. After a third grilling in March, she had said she "always acted in the interest of the country and in accordance with the law".
"After three years of procedure the only surviving allegation is that through inattention I may have failed to block the arbitration that put an end to the long standing Tapie litigation," Lagarde told AFP Wednesday.
She had until now avoided formal charges that could have forced her to quit as head of the IMF, and had instead been placed under a special witness status that forced her to come back for questioning when asked by the court.
Five people have also been charged in the case, including Stephane Richard, then Lagarde's chief of staff, now boss of telecoms giant Orange.
Questioning has in the past revolved around a signature stamp used in a letter dated from October 2007 that investigators think is crucial in determining who took the decision to resort to an arbitration panel.
Lagarde says she was unaware of the contents of the letter and has told judges it was stamped with her signature in her absence.
In France, those found guilty of "negligence" can be sanctioned by a year in prison and a €15,000 fine.