The head of the Vatican Bank, Ettore Gotti Tedeschi, is under investigation as part of a money-laundering inquiry, police sources say. Prosecutors also seized 23m euros ($30m; £19m) from the bank's accounts with another smaller institution.
The inquiry was launched after two suspicious transactions were reported to tax police in Rome.
The Vatican said it was "perplexed and astonished", and expressed full confidence in Mr Tedeschi.
The Vatican Bank, known officially as the Institute for Religious Works (IOR), was created during World War II to administer accounts held by religious orders, cardinals, bishops and priests.
Police interventionRome magistrates are looking into claims that Mr Gotti Tedeschi and the bank's chief executive Paolo Cipriani violated laws that require banks to disclose information on financial operations.
The BBC's David Willey in Rome says the Bank of Italy's financial intelligence unit tipped off Italy's tax police last week, after two suspicious transactions were reported between the Vatican Bank and two different Italian banks.
The tax police seized 23m euros that the Vatican Bank had tried to transfer from a small Italian bank called Credito Artigianato.
Some 20m euros was destined for JP Morgan in Frankfurt, with the remainder going to another Italian bank, Banca del Fucino.
Reports say the Vatican Bank had failed to inform the financial authorities where the money had come from.
Past scandal In a statement, the Vatican strongly defended its record.
"The Holy See is perplexed and astonished by the initiatives of the Rome prosecutors, considering the data necessary is already available at the Bank of Italy," the statement said.
And the Vatican also gave its backing to the two officials under investigation.
"The Holy See wants to express the maximum confidence in the president and in the chief executive of the IOR," it said.
Mr Gotti Tedeschi, who is an expert on financial ethics, has been in charge of the bank for a year. He was formerly head of Spanish bank Santander's Italian operations.
The Vatican Bank was last mired in scandal in 1982 when its governor Archbishop Paul Marcinkus was indicted over his involvement with the collapse of what was then Italy's largest private bank, Banco Ambrosiano.
Although he was never arrested, the fallout from that scandal took a darker turn when two of its top executives, one of them its chairman, Roberto Calvi, were murdered.
Calvi, known as God's Banker because of his close ties to the Vatican, was found hanged under Blackfriars Bridge in London.
SIC: BBC/EU