Based on empirical evidence, the authors argue that the proposed Basel Capital Accord risks 'institutionalising' the current low levels of international bank lending to developing countries. This is because, by failing to incorporate the benefits of portfolio diversification effects into banks' capital adequacy requirements while at the same time requiring a significant increase in capital requirements for loans to lower rated borrowers, the current proposals would cause an increase in cost and/or reduction in quantity of bank lending to developing countries. Given that the purpose of the new Basel proposal is to better align regulatory capital with actual risk, the authors therefore suggest a modification of the present proposal with respect to internationally diversified lending, in order to reflect the accurate measure of actual risk at the portfolio level.

May 28, 2003.