If found guilty, the IMF managing director could receive a maximum one-year prison sentence and a 15,000-euro fine
She arrived under the glare of television cameras at the Court of Justice of the Republic in Paris, a tribunal that hears cases against ministers.
The 60-year-old has been charged with negligence during her time as finance minister from 2007-2011 when she approved a payment to Bernard Tapie, the former owner of sportswear giant Adidas.
Tapie claimed a state-owned bank had defrauded him of hundreds of millions of euros when he lost control of the sports brand. Lagarde approved a settlement of 404 million euros (428 million dollars) in 2008.
Lagarde told the court she had been "profoundly shocked" by the conclusions of investigating judges who brought the case to court after deciding she had failed to question the deal.
"I acted in all honesty and in confidence with the public interest as my only objective," Lagarde said, adding that she had perhaps been duped but "was I negligent? No."
If found guilty, the IMF managing director could receive a maximum one-year prison sentence and a 15,000-euro ($15,900) fine.
Whatever the outcome, the case risks damaging the image of the former corporate lawyer who progressed through the finance ministry to become one of the world's most powerful women and is still spoken of as a potential future French president.
Surrounded by television cameras at the start of proceedings and wearing a dark suit with a patterned scarf, Lagarde's expressions alternated between awkward smiles and grimaces.
The case also threatens the credibility of the International Monetary Fund, as the former high-flying corporate lawyer is the third IMF chief to face trial.
The IMF has given its full backing to its yoga-loving boss, who began her second term in the post in July.
Her lawyer Patrick Maisonneuve on Monday dismissed speculation about what the IMF would do if she lost the case.
"She will be cleared so the question hasn't even arisen," he told Europe 1 radio.
Tapie, a former government minister now aged 73, owned Adidas between 1990 and 1993 but lost control of it when he went bankrupt.
He sold it to state-owned bank Credit Lyonnais for 315.5 million euros in February 1993. The bank sold it on the year after at 701 million euros, leading Tapie to claim he had been cheated.
Lagarde, upon becoming finance minister in 2007 under then president Nicolas Sarkozy, ordered that Tapie's battle with the state be resolved by arbitration.
The decision was hugely costly, with Tapie initially walking away with 404 million euros. After a lengthy court battle, he was ordered to repay the money.
Investigators suspect the arbitration process was rigged in favour of Tapie, who had supported Sarkozy in his 2007 election campaign. One of the arbitrators also had links to the businessman.
The prosecution says that through her actions, Lagarde "deprived the state of a chance to avoid this money being misused".
In an interview with the Journal du Dimanche newspaper published Sunday, Tapie insisted that Lagarde "never did me any favours".
He is among six people charged in a separate fraud case related to the payout, including the head of telecoms company Orange, Stephane Richard, a former aide to Lagarde.
Lagarde is being judged by a panel of three judges and 12 lawmakers selected from France's upper and lower houses of parliament.
She succeeded her disgraced compatriot Dominique Strauss-Kahn as IMF chief after he resigned to fight sexual assault charges.
Another former IMF head, Spaniard Rodrigo Rato, is currently standing trial for misusing funds when he was head of Spanish lender Bankia.
As well as Adidas, Tapie also owned the Olympique Marseille football club when they won the 1993 European Cup, the forerunner of the Champions League, but they were later embroiled in a match-fixing scandal.