Over the weekend, sleuths from India's external intelligence agency and other spy departments grilled the monk and his key associates, after vast amounts of money that were unaccounted for were found in their possession.
Police and income tax officials said they recovered more than 80 million rupees (S$2.2 million) in various currencies from the Gyuto monastery used by Mr Ugyen Trinley Dorje, 25, who may one day succeed the ailing 75-year-old Dalai Lama.
A large part of the money seized on Thursday was in Chinese yuan, and officials speculated that the cash was being stored for a real estate transaction that was to have been clinched last Saturday.
A local businessman has been arrested and Gyuto associates questioned. The police said the Karmapa himself has not been held, but acknowledged 'some restrictions on his movements'.
The raid on the monastery and the questioning of the Karmapa underscore Indian nervousness over what it fears could have been a move to set up Buddhist centres along the China border, a factor that could influence future negotiations on the undemarcated boundary.
While India has not, thus far, restricted Mr Dorje's movements within the country, New Delhi has not allowed him to move his residence to Rumtek monastery in Sikkim state, the traditional seat of the Karmapa.
Intelligence sources said that while it is not uncommon for popular religious figures to attract large amounts of cash in donations, their worry is that a substantial part of the yuan recovered had running serial numbers, which they described as 'unusual'.
'One thing is certain - it is illegal to keep such large amounts of foreign money in cash,' said China watcher Sujit Dutta.
Gyuto monastery is located in the Himalayan hill town of Dharamsala, which is in northern India's Himachal Pradesh state. It is the headquarters of the Dalai Lama's so-called government-in-exile.
The Indian government does not officially recognise the government-in-exile, choosing instead to refer to it as the 'Dalai Lama's Bureau'.
The head of Tibetan Buddhism has reacted cautiously to the raids, as well as the frenzied speculation in the Indian media.
'The Karmapa has many devotees, including those from China,' the Dalai Lama, who was in Bangalore, told reporters on Sunday. 'Some money would naturally have been received by him. There has been some negligence. It is better to have a thorough investigation.'
The Karmapa said the yuan unearthed in the raids came from followers in Tibet. 'All our dealings are honest and completely transparent - anything else would be contrary to the Buddhist principles that we live by,' said a statement from his office.
Beijing has not been amused by the developments, which come after three Chinese tourists, who strayed into India across the open border with Nepal, were picked up by the police during the middle of last month on suspicions of spying.
'The speculation by India's media shows that India keeps its mistrustful attitude towards China,' the Global Times quoted United Front Work Department official Xu Zhitao of the Communist Party of China's Central Committee as saying.