"The Holy See deems it appropriate to authorize a period of leave from the diocese for Franz-Peter Tebartz-van Elst," the Vatican said in a statement.
"The Holy Father has been continuously and objectively informed of the situation," it said. "A situation has been created in which the bishop can no longer exercise his episcopal duties."
It did not specify how long the bishop would have to stay away but added that this would depend on an analysis of the finances of his Limburg diocese and the responsibilities for its high costs.
The German press reported he would return to his duties after three months.
The Central Committee of German Catholics, which brings together all the Catholic lay associations in the country, said it was satisfied with the decision to suspend the bishop.
"Pope Francis' decision offers a chance at a new beginning in the diocese of Limburg where the situation has become heavy in recent weeks both for believers there and for the Church in Germany as a whole," its president Alois Glück said.
The bishop flew to Rome last week with low-cost airline Ryanair to explain himself to Francis - following accusations he took an expensive ticket on a trip to India and squandered money.
His private quarters in a new diocesan building are reported to have cost
some €2.9 million and included a 63-square-metre dining room and a €15,000 bathtub - using the revenue from a religious tax in Germany.
The reports have caused a scandal in Germany and sparked calls for greater transparency in Catholic Church finances - a reform aim of the new pope who has called for a "poor Church for the poor".
"The pope has already shown he can act energetically," said Marco Politi, a Vatican expert writing for the Italian weekly L'Espresso, giving the example of two Slovenian archbishops sacked for their poor financial management.
"Good management of money is essential for him... He has said that priests, even when they are buying a car, should think about children going hungry in the Third World," Politi told AFP.
Asked for a reaction after Wednesday's news, government spokesman Georg Streiter said: "There is no comment from the German government. This is an internal matter for the Church."
The 53-year-old bishop is under fire over the ostentatious building project in the ancient town of Limburg, which includes a museum, conference halls, a chapel and private apartments.
The project was approved by his predecessor and was initially valued at €5.5 million but the final bill ballooned to €31 million and included a garden costing €783,000.
Tebartz-van Elst is also accused of giving false statements in court about an expensive flight he took to India to visit poor communities.
Prosecutors say the bishop gave false statements under oath in a Hamburg court battle against news magazine Der Spiegel about the flights.
Anger that taxes paid to the Church by ordinary Germans are apparently being squandered has led to demonstrations outside his residence.
German Chancellor Angela Merkel, daughter of a Protestant pastor, said earlier via her spokesman Steffen Seibert that "I can express the hope that there will be an answer for believers, for people's confidence in their Church."
The embattled Tebartz-van Elst has defended the project, saying the centuries-old cathedral complex adjacent to the modernist new structure is heritage protected, complicating the development.
Critics within and outside the church have contrasted the premium architectural project with the more humble style of Pope Francis and asked how much good the money could do if used as aid in poverty-stricken African countries.
Pope Francis has made several key gestures of a more humble style since coming to office in March and has condemned big-spending clerics.
The pontiff has refused to move into the lavish papal palace in the Vatican, staying instead in the Casa Santa Marta, a residence for visitors.
He has repeatedly called for the Catholic Church and its faithful to rid themselves of earthly concerns like his name-sake, St Francis of Assisi, warning that "worldliness is a murderer because it kills souls, kills people, kills the Church."
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