Talks collapsed over Mr Pinault's possible cooperation

Prosecutors allege that the bank used illegal front companies to take over Executive Life in 1991.

The announcement of an investigation follows a failure of the French and US Governments to agree a settlement.

A successful prosecution could result in Credit Lyonnais losing its valuable US banking licence, as well as possible sanctions against individuals.

At the centre of the case is French tycoon Francois Pinault, who allegedly looked after Executive Life's assets in order to disguise Credit Lyonnais' involvement.

Talks collapse

The purchase of Executive Life, prosecutors say, was structured in such a way as illegally to avoid restrictions on foreign ownership of US insurers.

Credit Lyonnais allegedly passed on the insurer's assets, mainly in the form of junk bonds, to Artemis, a firm owned by Mr Pinault, a close friend of President Jacques Chirac.

Officials on both sides of the Atlantic have been struggling to avoid a criminal case for years.

A deal had been reached which would have broadly indemnified Credit Lyonnais and CDR, a French state agency that manages some of the bank's assets.

But talks broke down when the French Government rejected Washington's insistence that Mr Pinault receive only limited legal protection.

Last ditch

According to media reports, US prosecutors wanted Mr Pinault to put up a surety of $185m, and allow his $250m stake in Artemis - now renamed Aurora - to be frozen.

The financial commitment was seen as a necessary guarantee of good faith ahead of any possible civil legal action.

French Finance Minister Francis Mer insisted that the affair could still be resolved through negotiation.

Most observers believe that a settlement of some sort will eventually preclude outright criminal penalties.

Credit crunch

But if the investigation drags on for much longer, the consequences for Credit Lyonnais could be all the more severe.

The bank, which is now privatised after nearly going bankrupt and being bailed out by the state in the mid-1990s, is believed vulnerable to having its US banking licence withdrawn.

The Executive Life affair is the most unrelenting in a series of scandals that haunt Credit Lyonnais, mainly resulting from its activities in the 1980s and 1990s.