Bank of Montreal is being caught up in a widening probe into the use of bailout funds by American International Group, the distressed U.S. insurer.

Payments made by AIG to Canada’s fourth-largest bank are due to be examined by the New York Attorney-General Andrew Cuomo as part of an inquiry into billions in taxpayer money funnelled to financial institutions.

The investigation comes as the attention of U.S. lawmakers turns to the payouts to banks following a political firestorm over bonuses handed by the insurer to staff at a controversial unit that sold credit protection to sophisticated financial clients.

"Our investigation into corporate bonuses has led us to an investigation of the credit default swap contracts at AIG," the Attorney-General’s office said.

BMO declined to comment.

The payments and bonuses are all linked to a small part of the U. S. insurer’s international empire known as AIG Financial Products, which sold protection against default on complex credit instruments.

The tiny unit based in London effectively dragged down the global giant when it faced collateral calls it could not meet from BMO and at least two dozen other clients after the credit crisis intensified.

BMO is one of the top 10 recipients of federal bailout money paid by the stricken insurer to counterparties, according to documents released by AIG earlier this month under pressure from Congress.

The documents showed a least US$1.1-billion of bailout money was paid to BMO in 2008 to settle insurance contracts protecting the Canadian bank against losses on its credit investments.

Goldman Sachs received US$12.9-billion, while Société Générale and Deutsche Bank were paid nearly US$12-billion out of the nearly US$180-billion used to prevent a collapse of AIG.

"The question is whether the contracts are being wound down properly and efficiently or whether they have become a vehicle for funneling billions in taxpayers dollars to capitalize banks all over the world," said the Attorney-General’s office.

The probe is significant for BMO because it could lead to attempts by U.S. authorities to claw back funds. The Canadian bank may also have additional exposures to AIG that it is yet to be paid for or received further payments in 2009 that have not been disclosed, analysts said.