Following the collapse of the Soviet Union, the Republic of Azerbaijan has adopted the strategy of transition to a market economy. The implementation of economic reforms during the transition period helped to create the basic conditions for the market economy.

As these conditions came into existence, there was laying a foundation for the formation of the financial market, one of the attributes of a new economic system. The world practice has already proven that the financial market serves the economy effectively when it operates on the principles of full independence.

First of all, a proper normative-legal base and a favorable macroeconomic environment had to be created for the formation of a financial market in Azerbaijan that would meet the requirements of the new economic system. Laws of the Republic of Azerbaijan on Central Bank, Banks and banking, Securities, Insurance, Investment funds have already been adopted in Azerbaijan.

After the transition to the two-stage banking system in Azerbaijan in 1991, an important step towards the formation of credit, an essential element of the financial market, was taken. The number of commercial banks began increasing rapidly after the creation of a legal base for them. Most of the newly established banks attracted high-interest rates from the population and used those funds for speculative deposits in the foreign exchange market.

Inadequate regulation of banking practice, professionalism, as well as commercial banks by the Central Bank led to the collapse of the banking system. Tens of banks went bankrupt, deposits of tens of thousands of depositors were not returned. As a result, there was a strong sense of mistrust and disloyalty among the community to commercial banks which were the first representatives of financial intermediation in Azerbaijan.

During 1992-1995, there was a tense situation in the macroeconomic life of Azerbaijan like hyperinflation, the rapid devaluation of the national currency. The rapid depreciation of manat led to loss its functions and the risk of its rejection by the population. The hyperinflation rate in those years was due to increased budget deficits and elimination of that deficit at the expense of additional cash issuance by the Central Bank, the expansion of money as a result of unreliable amounts and interest rate centralized loans, and an excessive increase in imports.

Inflation was under control and interest rates were brought to a positive level in real terms. Although interest rates have declined in nominal terms, they have actually risen significantly. Thus, an interest rate is formed above the inflation rate, which is essential for the transformation of savings into investments.

At the same time, thanks to the implementation of the stabilization program, the exchange rate was stabilized and the manat's position against foreign currencies, including the US dollar, was strengthened. This has also contributed to building confidence and confidence in the national currency among the public and business circles.

But gaining stability in macro-finance is not enough for the formation of financial system in the country. Many problems still remain in this field. It is known that the national income per capita needs to exceed a certain level for the development of the financial market in every country.

The economic stagnation, which has continued since 1992 to the recent years, has greatly reduced the level of national income per capita and has led to the meltdown of collection by population and businesses.

The low collection rates in the country do not allow the formation of the national financial system in a way that will serve the economic development at a high level. In other words, the country has a low potential to mobilize sufficient financial resources to finance the investment costs necessary for economic development.

One of the reasons that prevent the formation of the financial market in Azerbaijan is the problem of dollarization of the national economy. Dollarization of the economy is the result of macroeconomic, political instability in the country, a socio-psychological environment where there is a public mistrust to the national monetary unit.

Dollarization represents the manifestation of cash dollars in turnover both as cash and investment means that is an alternative to money, because of the national monetary unit manat’s inadequate performance of its functions.

According to Keynes’ theory of demand for money, liquid maintenance (it is about the money that is a means of payment) depends on three motives - transaction, precautionary and speculative. In the liquidity preference on the transaction and precautionary motives, the reason for manat’s role being weak is its insufficient ability to convert to other assets quickly and easily and being subject to expectations of a loss of its value.

Although manat has the right to become the sole means of payment in the country, in practice most participants of the sales process do not prefer it. Another reason for the weakness of manat’s liquidity is the imperfection of bank settlements.

Subjects who keep their money in a settlement account of a bank, cannot perform many of these procedures with the help of it. In the shadow economy where most of the economic agreements are implemented, the dollar is preferred as a means of payment.

In recent years, the market of privatization cheques has revealed the factor of demand for liquidity due to speculative motives in relevant to the formation of the market. In this case, manat has almost given its place to the dollar. The speculators who wait for the cheques’ price drop, make a demand not for manat, but for dollars.

During the registration process of privatization cheques carried out recently by the State Committee for Securities, it was revealed that about half of their total volume is in the hands of speculators. This fact shows that speculative turnover in the cheque market can be measured with tens of millions of dollars.

That means the price fluctuation of cheques reveals currency supply and demand that can be measured by tens of millions of dollars. Undoubtedly, this process influences the aggregate supply and demand of the country in the foreign exchange market.

As we have already noted, the dollar is not only a means of liquidity preference but also an alternative to investing money. Despite the dollar's unprofitability, the high level of conversion rate between manat and dollar, the strength and the high convertibility of the dollar make it an alternative type of wealth.

Thus, the foreign currency - the dollar, which has high liquidity and the ability to maintain its real value, squeezes manats as liquidity means on one hand, and on the other hand, acts as the main alternative to manat. In other words, the dollar is also a type of wealth. People prefer dollars rather than financial instruments as an alternative form of wealth.

In addition to what we have said about the dollarization of the national economy, I would like to point out that the reason is not only the dollar has high liquidity and stability. Dollars also provide anonymity for wealth. Individuals prefer to keep their wealth in the form of anonymity only for the purpose of concealing their wealth from the eyes of the state and the general public.

On the other hand, the fact that the dollar can be converted in all countries, and it is possible to easily move it out of the country, is one of the main reasons for preferring dollars.

Given the risky scale of dollarization for the economy, there is a need for the program to thrive. For this purpose, first and foremost, macroeconomic and political stability must be sustained, public confidence in the manat should be established. Healthy, strong foundations should be created so that people can make their own decisions about the future.

In addition to all these problems, radical economic changes in recent years, including privatization, provide an economic basis for the formation of the financial market. The privatization of small and medium-sized enterprises creates a corporate stock market. It requires a lot of formations.

The functioning of the financial market depends to a great extent on the legal base created for it. As mentioned above, certain legislative acts were adopted in this field. However, there are certain shortcomings with regard to legalization in this area.

Unfortunately, financial legislation is not based on research and appraisal of the facts, but rather on the template implementation of the relevant laws of foreign countries, as well as the developed countries.

For example, if there is no investment fund in Azerbaijan, what is the scientific basis for establishing relevant laws and restrictions, as it is in developed countries?

In our opinion, first of all, there is a need to adopt a law that defines the general principles of functioning of the financial market and the activities of intermediaries.

This law should include the general procedure for participation in the financial market, the general requirements for financial instruments, the intermediaries authorized to operate in the market and their functions, the rights and duties of the state regulatory body.

This law should maintain competition in the financial market, ensure transparency and objectivity of participation.

In addition to the above, it should be noted that some of the laws adopted also are not perfect. For example, according to the insurance law, an insurance company must first invest its own funds in the securities of state and government entities. First of all, this is contrary to the principle of competition.

On the other hand, such a rule does not allow an insurance company to use its assets efficiently. Instead of encouraging investment, legislators seek administrative support to meet the state's budgetary needs.