13 Mar Why a multilateral defence and security bank?

In the few weeks since President Trump upended United States’ policy on Ukraine, European nations including the UK have been forced to reassess at speed the foundations of their own security. Two strategic imperatives – to persuade the United States to remain engaged in Europe, while preparing for the eventuality that it doesn’t – both point firmly towards the need to fund substantial new defence security and resilience capabilities quickly, in many cases from a disturbingly low base. This will cost big money – somewhere between €500 -800bn – that European countries seem to be unwilling or unable to take from domestic priorities and will not be able to borrow on the markets in conventional ways. Only with an innovative approach could Europeans hope to fill the gap.

Last week Foreign Secretary David Lammy expressed his support for a multilateral defence and security bank that would provide additional borrowing capacity to governments to fund security and defence needs. While the precise structure is yet to be agreed, the UK’s role in such a bank, alongside EU and other non-EU member states on the one hand fits well with the current UK Government’s wish to ‘reset’ the relationship with Brussels, while at the same time reflecting London’s unique role in Europe in defence, security and finance.

The concept of a multilateral defence and security bank (DSRB) is particularly attractive for three reasons:

(1) A multilateral bank of this kind would be funded by initial capitalisation from its founding members. This would ensure it a triple A credit rating allowing governments to borrow for defence procurement on favourable terms.

(2) Borrowing by governments from multilateral lending institutions is treated as “contingent liabilities” on government balance sheets and therefore does not add to aggregate government debt, which for some countries is already at worryingly high levels.

(3) Borrowing from a multilateral bank would oblige governments to ensure that their defence procurement processes satisfied the bank’s investment appraisal disciplines, thereby allaying fears that inefficient procurement practices would limit the impact of the new funds.

In other words, a multilateral bank can make a significant difference to the way in which defence is funded as well as to the sums available, without increasing the risks associated with greater national debt. At a time where Europe and the UK have high levels of debt, the multilateral bank solution is an effective, and well-established, way to square the circle.

BFPG’s Economic and Trade Security Commission has been working on mechanisms to ensure that defence and supply chain funding is fit for purpose in an era of multiple and novel threats. Our discussions have involved Government, UK-based banks, partners in the defence ecosystem and academic experts working to understand the real obstacles to greater private sector involvement in defence and security supply chains. The Commission has met formally and in smaller formats to draw up a framework for financing resilience in defence and security.

Our work suggests that a DSRB would be the most effective mechanism for increasing funds available for defence spending by accelerating the allocation of funds to producers within the defence industrial base. Though working capital may be less well understood than innovation funding, deployed effectively it can ensure that defence and security manufacturers have the required cash flow to service defence contracts in which a large proportion of the value of the contract is paid up front. In other words, the contract itself becomes a financial instrument.

However, increasing compliance demands, combined with the volatile and unpredictable nature of defence contracts, means that many commercial banks have been reluctant to support the sector, particularly SMEs. With today’s urgency to generate enhanced capabilities, it is critical to find ways to ensure that the industrial base can scale quickly to meet new demands and absorb additional funds. A DSRB approach can help create more efficient and standardised processes to manage risk without the need for obstructive compliance requirements.

Discussion in the Commission highlighted the attractiveness of a DSRB because it could address these ‘supply side’ considerations by providing guarantees for commercial banks financing Critical National Infrastructure projects. In other words, the inherent risks associated with these deals would be mitigated by the guarantee (or insurance) provided by the DSRB. This is a well-trodden path. The European Bank for Reconstruction and Development (EBRD) uses precisely this model and it works, in tandem with national providers of guarantees such as UK Export Finance (UKEF) offering security for riskier deals.

From the British perspective, there is a unique opportunity here for the UK to deploy key elements of its ‘soft power’ in support of enhancing European security ‘hard power’. By playing a leading role in the creation of a DSRB located, for example, in London, the UK would be ideally placed to reinvent in the new geopolitical reality its traditional role as the ‘bridge’ between European collective defence and the United States, maintaining and reinforcing the vital transatlantic relationship.

In support of this approach, the UK could put into service a number of its own institutions as building blocks for a new DSRB:

(1) UK Export Finance provides defence and security guarantees to UK exporters and is keen to work with the banking sector to improve take up.

(2) The National Wealth Fund and the British Business Bank have been mandated to provide more funding to defence and security.

(3) Commercial banks in principle appear willing, from research conducted by the Economic and Trade Security Commission, to participate in defence deals provided they are guaranteed, not just for credit risk but for the role that these contracts play in national security.

There is now a need to take a more unified approach to ‘pure’ defence in the context of broader national security. We have arguably for some time been operating in a state of ‘economic conflict’ in which sanctions, export controls and financial restrictions are being used to constrain adversaries. At the same time, high levels of public borrowing taken on to address cost of living pressures since Russia’s invasion of Ukraine have limited the country’s ability to finance growth, and defence. This reinforces the urgent need to pay more attention to the role financial levers can play in deterrence.

The DSRB offers an opportunity to address these twin challenges by providing the structures to address procurement challenges and capital deployment to the industrial base, which is where the effects on economic growth will be most felt.