In 1988, the BCBS published a regulatory framework in Basel, Switzerland, to set the minimum capital that a bank needs to hold to minimize the risk of insolvency. The so-called First Basel Accord, which is now referred to as Basel I, was enforced by the law in all of the G-10 countries by 1992. By 2009, 27 jurisdictions were involved in the Basel Regulatory Framework (the history of the Basel Committee can be read at http://www.bis.org/bcbs/history.htm).
The first Basel Accord mainly focuses on credit risk, and formalizes the appropriate risk weighting considering different asset classes. Based on the Accord, the assets of banks should be classified into categories regarding credit risk, and the exposure of each category should be weighted with the defined measures (0 percent, 20 percent, 50 percent, and 100 percent). The resulted value of risk-weighted assets (RWA) is used for the determination of capital adequacy. According to the Basel I legislation...