Resolving the Interest Rate Premium Puzzle: Capital Inflows and Bank Intermediation in Emerging Economies

This paper develops a simple bank-based analytical framework to explain why and how capital inflow surges and lending booms could lead to higher real interest rates in the domestic economy, even after adjusting for country/currency risk premia and exchange rate changes. While this phenomenon of ever-rising capital inflows and sustained possibly, even widening interest rate spreads is an important stylized fact in East Asia prior to the 1997-98 crisis, it may be more generally applicable to emerging economies experiencing lending booms.