European countries need to raise at least an additional €1 trillion to meet their NATO commitment to raise core defence spending to 3.5% of GDP by 2035 and an additional 1.5% for defence-related infrastructure and resilience. While some allies are racing ahead, several major European nations are falling behind because of national fiscal constraints. There is, hence, an urgent need for more resources than many EU countries’ budgets can provide at a time when government borrowing costs have risen to multi-decade highs.
According to NATO estimates for 2026, Poland and the three Baltic states have already reached, or are close to, 5% of GDP on core defence expenditure alone. The four Nordic allies and Greece are above or approaching the 3.5% core military spending target. Germany, Europe’s largest economy, has announced plans to achieve that goal by 2029 through an unprecedented surge in defence expenditure, funded by a special national borrowing programme. By contrast, some highly indebted European allies, notably the United Kingdom, France, Italy and Spain, are struggling and lack the leeway to increase national borrowing or raise taxes significantly. Slashing welfare or pension spending is not politically feasible. Spain has a healthier growth rate, but its government rejects the NATO target. The others have suffered several years of relative economic stagnation.
The EU can contribute significantly to Europe’s defence surge (https://d1xp398qalq39s.cloudfront.net/content/Defence_surge_policy_brief.pdf) and has already become an important pillar for European security and resilience. There are different options for the “how”, and political hurdles will need to be overcome to organise majorities.
The first-best solution, call it Plan A, would be to considerably increase funding for joint arms procurement in the EU’s Multiannual Financial Framework (MFF), the seven-year budget currently under negotiation for the period 2028-2034. However, the fivefold increase to €131 billion in joint spending on defence and space proposed by the European Commission (https://commission.europa.eu/strategy-and-policy/eu-budget/long-term-eu-budget/eu-budget-2028-2034_en) is unlikely to be approved in full by member states, given national lobbying for traditional agricultural and regional spending and a drive by frugal net contributors to curb the overall EU budget. And it only kicks in from 2028.
The contribution of the future EU budget to defence could be complemented by a new joint borrowing initiative along the lines of the NextGenerationEU economic recovery fund launched during the COVID-19 pandemic, this time dedicated to defence. However, so far, the frugal EU countries with the highest national credit ratings, Germany, the Netherlands, Austria and Finland, have rejected joint borrowing, or indeed a continuation of NextGenerationEU, which expires in 2026.
A second option is the scope for a significant role in defence financing for the European Investment Bank, which has a triple-A credit rating. The EIB has widened its mandate to allow more defence-related lending, but uptake has been slow. It lent €4.5 billion for defence and security projects in 2025, roughly 5% of its total financing, up from €1.2 billion in 2024. But this share is still small.
Although the EIB cannot finance weapons, ammunition, or purely military assets, its contribution to NATO targets would come in financing the 1.5% “broader defence and security” category — especially dual-use infrastructure, cyber resilience, critical infrastructure, and defence industrial expansion — thereby freeing national budgets to focus on the 3.5% core defence requirement. The EIB can also usefully complement the Commission’s €150 billion Security Action for Europe (SAFE) loans by co-financing defence-related projects in line with its mandate.
This would create a euro-denominated safe asset, European defence bonds, that would strengthen the international use of the euro and offer cheaper credit to member states. However, using the EIB in a more ambitious way could sidestep concerns about new joint borrowing, especially if the 27 EU member states, whose finance ministers are governors of the bank, agree to a capital increase.
An alternative to a new NGEU-type initiative would be for a coalition of willing governments to create a Special Purpose Vehicle by treaty that would borrow on capital markets with a joint-and-several liability guarantee. This could also enable non-EU nations such as the UK, Canada, Norway and Türkiye to participate. However, to achieve a AAA rating, such a mechanism would need some of the most solvent European nations to join. There may also be a role for the existing European Stability Mechanism (ESM) that was created during the eurozone debt crisis as a conditional rescue fund for euro member states that lost market access but was never used for that purpose. This would, however, require an amendment to the ESM treaty to allow it to lend for defence, and it would only cover euro zone members.
A third option is to raise the money through a dedicated defence bank. Efforts in this direction took a step forward at NATO’s Ankara summit when nine nations, Albania, Belgium, Canada, Greece, Latvia, Luxembourg, Romania, Türkiye, and Ukraine, announced support for a new Defence, Security and Resilience (DSR) bank led by Ottawa, to be structured as a multilateral financial institution with member nations inputting core capital and holding in reserve callable capital. Their borrowing quota would be linked to their capital stake, with partners putting in Ukraine’s capital share. Leveraging a strong credit rating, the bank aims to provide long-term, low-cost financing for defence, security, and resilience initiatives across supply chains, helping governments and small and medium-sized enterprises address critical financing gaps. It will provide guarantees to commercial banks that increase the availability of affordable capital, while also offering loans to member countries for priority investments. The aim is to have the bank operational in 2027. However, none of the European G7 countries has yet agreed to participate. Germany’s Finance Ministry has so far rejected joining the DSR bank, although its own defence industries’ association backs the idea.
The UK initially rejected joining the DSR bank and launched a separate Multilateral Defence Mechanism (MDM) with the Netherlands, Finland and Poland aimed at providing finance for joint arms procurement. However, former Chancellor of the Exchequer Rachel Reeves said the MDM should merge with the DSR bank to avoid having to capitalise two lenders, and her successor, former defence secretary John Healey, is believed to support the DSR bank. (https://www.ft.com/content/fe160ac5-3ef8-423f-b758-b43ff6096c43?syn-25a6b1a6=1). Bringing the two initiatives together would create a potent institution, potentially including non-NATO democracies such as Japan, South Korea and Australia in line with Canadian Prime Minister Mark Carney’s view of coalitions of like-minded middle powers taking plurilateral action to defend common interests.
The snag with defence banking initiatives, apart from the initial abstention of key players, is the time it will take to get finance flowing compared to the pressing defence emergency Europe faces. European countries need to invest more in defence now, not in two or three years’ time or longer.
Europe rarely works in straight lines.
The snag with defence banking initiatives, apart from the initial abstention of key players, is the time it will take to get finance flowing compared to the pressing defence emergency Europe faces. European countries need to invest more in defence now, not in two or three years’ time or longer.
Europe rarely works in straight lines. Plan A would require a greater leap forward in integration than Germany and its frugal allies seem willing to make, especially in joint borrowing. The suboptimal European solution is therefore likely to combine a number of initiatives rather than a single Cartesian financing plan through the EU institutions. Such a matrix should include:
- some outright grants for defence from the new MFF from 2028,
- further leveraging of the unspent headroom in the EU budget to fund a second round of cheap loans along the lines of the existing SAFE, open to Canada, the UK and Türkiye in return for financial contributions,
- a step change in defence-related lending by the EIB, and
- a multilateral defence bank based on the DSR bank with a procurement arm enabling the institution to hold expensive key capabilities off national balance sheets for a prolonged period.
Since Plan A is unlikely to materialise in full, given dogged sovereignist opposition, Europe needs as coherent a Plan B as possible. It will take several fishing boats to catch all the fish.
The EIB should significantly increase defence-related funding through loans, guarantees and direct equity, while also helping mobilise private funding and support the emergence of a defence-related ecosystem of private firms. Although total EIB defence financing, even after scaling up, would most likely be more limited than a new NGEU-type defence programme and therefore should not be seen as a better alternative, it would nevertheless be politically less sensitive than launching a new joint-borrowing initiative. EIB defence-related bonds would also add to outstanding Euro-denominated safe assets, contributing to greater liquidity and, indirectly, to enhancing the international role of the euro. A multilateral financial institution based on the DSR bank offers additional opportunities to unlock private financing from commercial banks and lending to SMEs vital to the defence supply chain.
A coalition of willing European nations and Canada engaging directly in joint borrowing through an SPV remains an option for providing affordable finance to governments, but it would require German backing to succeed and might take too long to negotiate.
Berlin overcame deeply ingrained opposition to joint European borrowing once before during the COVID-19 pandemic. In defence as in public health, Europe is only as strong as its weakest link. Germany needs its allies for integrated air and missile defence, critical infrastructure and joint capabilities such as satellite intelligence, and cross-border military transport corridors. It backed the NextGenerationEU recovery fund, citing emergency circumstances. If defending Europe against a looming threat of Russian aggression is not such an exceptional situation, what is?
