Banking on Defence: Can a dedicated bank solve Europe’s rearmament financing dilemma?

Europe needs more money for defence, and it needs it fast. Our intelligence services and military commanders tell us we may have as little as three to five years to prepare for a potential Russian attack on NATO and EU territory, given Moscow’s transformation of its economy to a war footing. We already face a war of aggression against Ukraine which has upended the European security order, and a growing covert war within the EU involving sabotage, cyber-attacks, assassination attempts, disinformation and election interference. Yet most of our governments are fiscally overstretched and cannot suddenly conjure up the massive additional resources needed for a surge in defence spending. Other socially important priorities are vying with defence for scarce public funds - the energy transition, digitisation, education and healthcare. Public opinion in most European countries is willing to accept higher military outlays, but not at the cost of higher taxes or big cuts in welfare spending, polling suggests.

NATO leaders are expected to set a much higher defence spending target at their summit in June 2025 than the 2 percent of gross domestic product (GDP) which not all EU members yet meet. It would cost Europeans roughly an extra $600 billion a year to reach the 5 percent of GDP target sought by US President Donald Trump.

Faced with this conundrum, the European Union, or a coalition of willing states, could choose to borrow jointly on financial markets to front-load defence investment, as Germany has decided to do nationally by amending its constitutional debt brake to permit extra borrowing for defence and infrastructure. However, political barriers to collective EU debt issuance remain high, so several proposals have been advanced to address the problem through a dedicated bank or a network of existing banking institutions.

FAST, BIG AND EUROPEAN

This article examines four such proposals, based on three essential criteria - speed, scale and what we might call “Europeanness”. However, a fourth criterion - spending better - should be taken into account, since national defence procurement processes in most European countries are highly inefficient and lead to duplication, shortcomings in interoperability among allies, as well as delays and cost overruns. Streamlining and standardizing procurement is also a priority. A fifth criterion is how any defence bank could support Ukraine and its defence industry.

Given the need to achieve a step change in European defence investment and output in the next five years, time is of the essence. For that reason, among others, a solution cannot wait for the EU’s next Multiannual Financial Framework, which only enters into force in 2028. That would require an improbable unanimous agreement among the 27 EU members either to increase substantially the size of the EU budget - long pegged at about 1 percent of the Union’s GDP - or to reallocate spending radically from agriculture and regional development, which jointly consume more than 70 percent of EU expenditure. Neither is likely.

As part of its Rearm Europe plan, the European Commission has proposed issuing 150 billion euros in long-term SAFE loans secured on the Union’s budget for joint defence procurement projects. The allocation will be on merit and demand-driven, with no distribution key. Member states wishing to receive the loans will have to submit a European Defence Industry Investment Plan to the Commission, describing the planned activities, expenditures and measures, the defence products it intends to procure, and, where relevant, the involvement of Ukraine. Initial loans will be disbursed in 2025.

While the SAFE loans are welcome, the sums involved and the relatively small premium over national borrowing costs mean the Commission initiative is unlikely to be sufficient to drive the required surge in defence investment. A bigger scale of cheap lending and/or grants is needed to force the pace and change deep-seated national procurement biases. 

Ideally, the European Investment Bank, the EU’s soft-loan public investment arm, should fulfil that role of lending to member states and companies for defence projects. But its rules prohibit lending to purchase weapons and ammunition. While the EIB board of EU finance ministers has widened its remit to lend for dual-use technologies for defence, it is unlikely to embrace lending for strictly military purposes any time soon. So a dedicated lending institution for European rearmament is an urgent requirement. 

An intergovernmental bank established by willing EU member states and non-EU European countries such as the UK, Norway and possibly Turkey, could be a solution if a treaty establishing it can be negotiated and implemented quickly enough. Such an institution would have to be up and running by the end of 2025 and lending large amounts in 2026. That is a steep but not insurmountable challenge given the urgency of the geopolitical situation.

FOUR PROPOSALS

Four proposals to scale up public institutional lending are on the table ahead of European Council and NATO summits in June.

1) Building on national promotional bank institutions (NPBI)

Poland, a staunch NATO ally which holds the EU’s rotating presidency and has become the biggest defence spender in Europe as a percentage of GDP, has suggested that other EU countries build a network based on its own procurement system. Warsaw created an armed forces specially fund, managed by its national promotional bank institution, Bank Gospodarstwa Krajowego (BGK), leveraging the defence budget to borrow on the financial markets. Its borrowing is guaranteed by the Polish State Treasury and export credit agencies, ensuring favourable rates.

BGK’s experience in managing the fund could serve as a foundation for creating a European Defense Fund, co-managed with other banks. Creating a new fund through NPBIs offers several advantages. NPBIs possess in-depth knowledge of regional industrial ecosystems, enabling more tailored funding solutions for local companies and research institutions. They also facilitate faster and more efficient allocation of funds. NPBIs can combine EU, national and private funds, creating significant financial leverage, and integrating various instruments like defence bonds, preferential loans or investment guarantees. Their regional knowledge can help identify and supporting strategic companies in the defence supply chain, including R&D initiatives.

On the downside, some NBPIs, including Germany’s, have the same restrictions on financing arms and ammunition as the EIB. BGK proposes circumventing this problem by creating regional or task-based armament funds such as an existing one dedicated to the eastern flank of NATO.

2)  A European Defence Mechanism (EDM) to coordinate procurement

Commissioned by the Polish EU presidency, the Bruegel think-tank has proposed a European Defence Mechanism (EDM) to be created outside the EU treaty via an intergovernmental treaty open to all European states including the UK, Norway and Switzerland. Voting rights would be proportionate to members’ capital subscription, with no national vetoes. Crucially, countries that join would have to agree to renounce national preference in procurement and open defence acquisitions to competitive tendering.

The EDM, modelled on the European Stability Mechanism bail-out fund, would use conditionality of lending to create a common defence market, coordinate joint procurement to achieve economies of scale, lowering unit costs. It would finance major European strategic enablers such as air and missile defence, space-based intelligence and surveillance, command and control systems, strategic airlift and air-to-air refuelling tankers, which could be owned by the EDM, keeping the costs off the strained national debt of member states.

The proposal was presented to an informal meeting of EU finance ministers in April 2025 and received a cautious welcome, though some countries including Germany, France and Belgium argued that the EU should look to existing financing instruments, including Rearm Europe and the EIB, before creating new ones.

3) A European Rearmament Bank (ERB) modeled on the European Bank for Reconstruction and Development (EBRD)

A private group headed by former vice-president of the EBRD Guy de Selliers, journalist Edward Lucas and General Sir Nick Carter, former chief of the UK defence staff, have put forward a concept for a European Remament Bank. This specialised, rapid response institution was also inspired by Polish government ideas for a European military fund. Using the model of other multilateral banks such as the EIB and the EBRD, the bank would issue AAA-rated bonds leveraged on a relatively small amount of paid-in capital from member states, which would also set aside callable capital. The proponents say a 10 billion euro cash contribution from governments would leverage 250 billion euros in loans for defence.

The ERB would be open to all countries that are members of the European Political Community and of NATO, as well as to EU bodies such as the Commission and the EIB. The bank would be a leanly run financial institution combining banking and military procurement expertise and could become a centre of excellence for best practices on arms procurement.

Money would be lent to member states for specific contracts and to defence contractors. The ERB would lend to governments in proportion to their shareholding to make purchases and to companies from member and friendly countries to finance upfront development costs and capacity expansion. It would finance contracts awarded by competitive tender, open to all member countries with no national discrimination, giving preference to pooled orders with simplified joint specifications. It could also finance new defence equipment initiatives such as the EDM or stockpiles of ammunition or military vehicles. It would be immediately applicable to Ukraine.

An ambitious timeline suggested that operations could begin by the end of 2025 if the draft intergovernmental agreement were signed in June-July. To speed implementation, it would seek service agreements with the EIB and the ESM to provide back office support and help with initial capital markets activities.

4) A global Defence, Security and Resilience Bank (DSR)

A group of former NATO officials, working with international bankers and lawyers, has proposed a global Defence, Security and Resilience Bank (DSR), originally pitched in 2019 as a “NATO bank”. The internationally governed financial institution would lend to governments and to private companies executing government contracts, as well as underwriting risks for commercial banks lending to defence companies and their supply chains. It would be open to “allies across both the Euro-Atlantic and Indo-Pacific regions”, beginning with a small group of “anchor nations”, which might include members of the UK-led Joint Expeditionary Force of northern European nations, along with the United States and Japan.

The DSR proposal also aims to create a competitive defence market through loan conditionality and financial penalties. Assets such as weapons systems would be held on the balance sheet of the DSR to keep them off national debt. Its proponents contend that only global scale would secure the required massive funding and make the rearmament drive sustainable. They also argue that some key equipment can only be purchased outside Europe in the current emergency.

DSR proponents are hoping for first commitments from founder governments at a NATO summit in June and estimate the bank could be operational by 2027. They argue that it is necessary to look beyond Europe for capital and military industries in countries such as South Korean and Australia while concurrently building up production in Europe. A multinational defence bank would help overcome the limitations of annual defence budgeting and facilitate multi-year project planning.

CONCLUSION

The proposals are not mutually exclusive. An immediate start toward multilateral defence financing could be made by using regional groupings of NPBIs while gradually building a bigger defence bank. Reforms to drive more competition and joint procurement will be essential to spend Europe’s defence uplift more efficiently, but they face deep-seated resistance on both national security and old fashioned “pork barrel” protectionist grounds.

All the defence bank proposals build in the principle of competitive tendering without national preference in arms contracts. Yet however desirable an end to defence protectionism may be, it seems highly unlikely that the bigger West European countries with large defence industries will be willing to abandon national preference which is shielded by Article 346 of the EU treaty, giving member states a let-out from single market rules by invoking national security. The EDM proposal makes accepting competitive tendering a condition of membership of a new intergovernmental treaty in an attempt to circumvent Article 346. However, strong stances taken by the French and German defence industry associations in favour of home preference, and statements by the French defence minister in early 2025 appear to rule out any generalization of open trans-national tendering within Europe for military contracts.

What may be feasible is a two-tier system whereby governments continue to fund home-preference procurement out of their national budgets, while a European defence bank or EDM finances joint procurement projects for some equipment or capabilities subject to competitive tendering rules. The multinational projects would enjoy the incentive of joint financing on attractive terms and economies of scale, but if the big players stayed out, they would struggle to achieve critical mass. A single defence market is desirable but may founder on the rocks of national defence protectionism within the EU.

While all the proposals offer ways to partner with Ukrainian defence industries both to procure equipment for Kyiv and to buy Ukrainian capabilities for Europe, none of them explicitly envisages full membership for Ukraine. There is no convincing reason why Ukraine, which is fighting to defend Europe as well as itself and has developed an admirably nimble and highly competitive defence industrial base, should not be a full member from the outset. If it is unable to contribute capital, its European partners should pay its share as a form of financial aid. Rob Murray, the former NATO official founder of the proposed DSR bank, says he supports having Ukraine as a member of the DSR bank, which would be an important political signal.

Finally, the degree of “Europeanness” is the factor which distinguishes the first three proposals from the DSR bank. DSR proponents contend that only by involving the United States and Asian democracies can the bank gain critical financial mass and long-term sustainability and that some essential systems may only be accessible from non-European suppliers in the short term.

European countries are having to invest massively not least to replicate capabilities and enablers that the United States may no longer be willing to provide to NATO in this new era of strategic uncertainty. Having a financing instrument that allows for timely procurement from trusted non-European partners to meet urgent operational needs could complement other tools.

However, Europe needs first and foremost a European defence bank to build the European Defence Technological and Industrial Base, even if it comes in stages.

*This commentary was updated with additional information provided by DSR bank

Paul Taylor is a Senior Visiting Fellow with the Europe in the World Programme at the EPC. 

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