SÃO PAULO—Brazil´s Supreme Court on Thursday ordered jailed investment banker André Esteves released to house arrest, a blow to prosecutors who had sought to keep the financial mogul imprisoned while they investigate allegations against him in the country’s far-reaching graft scandal.

The decision reverses an earlier order by the court to jail Mr. Esteves, the former chief executive and controlling shareholder of BTG Pactual , pending trial on charges of obstructing justice in connection with a corruption probe centered on state-run oil firm Petróleo Brasileiro SA, or Petrobras.

Prosecutors allege that Mr. Esteves plotted with a legislator to buy the silence of a key witness whose testimony could implicate them in the Petrobras case. Authorities argued that the billionaire banker should remain jailed because he could use his vast wealth to disrupt investigations against him.

But the court agreed to release Mr. Esteves after his suspected co-conspirator told authorities he had fabricated the banker’s involvement in the bribery scheme.

Through his attorneys, Mr. Esteves has denied all wrongdoing.