Allogeneic islets encapsulated in an alginate/poly-L-lysine membrane and transplanted into diabetic BB/W rats resulted in graft failure within 2 weeks of transplantation. Graft failure was associated with a dense pericapsular infiltrate (PCI) that resulted in necrosis of the encapsulated islets. The PCI could be inhibited by immunosuppressive agents, including cyclosporine and dexamethasone, and this resulted in a significant increase in graft survival. Immunopathological characterization of the PCI indicated that there was a predominance of macrophages. T helper cells also appeared to be present in this PCI. Empty capsules were also found to induce a similar PCI that was identical in composition to that found around encapsulated islets. Thus alginate/poly-L-lysine capsules do not appear to be biocompatible and may account for the variable results in islet graft survival found with these capsules.