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The 1998 financial turmoil on international capital markets has suggested some weaknesses in the Basel Committee’s 1988 Capital Accord. Criticism has focused not only on the measures of risk used in this framework, but also on its ability to incorporate key insights from the theory of finance, such as the fact that it does not generate any capital advantage for banks that have well diversified portfolios. Moreover, it has also been recognised that bank capital pressures may have led to cyclical movements in banks’ lending, increasing macroeconomic instability.

The paper focuses on the latter issue. It assesses to what extent the new proposals by the Basel Committee-the New Capital Adequacy Framework-address the issue, taking account of the fact that, as underlined by Furfine (2000), banks tend to optimally respond to the economic incentives they find in the regulations.