Credible deterrence requires a new Nato bank

Mark Carney and Luc Frieden, Financial Times

The writers are the prime ministers of Canada and Luxembourg

The essence of deterrence is credibility. Since Russia's unlawful invasion of Ukraine, Nato allies have come a long way in strengthening their military capabilities. But it is not enough. Credible deterrence needs more: it needs to be backed by financial and economic power.

Our ability to mobilise capital must be just as reliable as our armed forces. The answer is a bold multilateral solution: the creation of the Defence, Security and Resilience Bank (DSRB).

The need for additional financing is obvious. Together with Nato allies, our countries have pledged to substantially increase defence budgets. This will require more than €850bn in additional annual spending across the alliance in Europe and Canada, which cannot come at the expense of other investment priorities at home.

Our new proposal builds on the tried and tested model of multilateral financial institutions such as the World Bank or the European Bank for Reconstruction and Development. While regulations limit commercial banks to lending about €12 for every €1 of capital into defence, the DSRB's multilateral guarantee architecture will allow them to lend more than twice as much.

The same principle that governs participation in the World Bank or EBRD will apply here too. Countries will provide both paid-in and callable capital. The former is provided immediately upon joining, giving the bank liquidity straight away. As this represents a balance sheet asset, it is recorded in debt figures, not annual deficit figures. Importantly, it also counts towards the Nato defence spending target of 5 per cent of GDP.

Callable capital, on the other hand, takes the form of guarantees, which are essential to secure a triple A rating. This is a sovereign promise from governments to the bank in case of need.

Increased spending is just one side of the equation. Our industrial base - especially SMEs such as precision engineers, drone start-ups and cyber specialists, who represent the essential components in defence supply chains - must be ready to meet the moment. They need to be prepared to ramp up production, seize export opportunities and accelerate the pace of innovation. But right now, they must contend with a structural market failure that limits crucial access to capital.

Despite strong signals from governments, capital management rules prevent the defence ecosystem from receiving financing at the volume it needs from private banks. As increased demand meets limited supply, prices increase - hurting all our efforts.

By issuing loan guarantees to private financial institutions, the DSRB will play a key role in reducing risk for the private sector and make it possible to crowd in sizeable amounts of additional capital for defence supply chains. It fills an important gap in the current architecture, tackling the structural issues that prevent the large-scale deployment of capital across defence supply chains.

The DSRB will lend exclusively to companies domiciled in the bank's member states, including the downstream supply chain. It will also lend directly to its member states. The bank can finance the most urgent categories of rearmament, while other financial institutions are prohibited from even investing in conventional weapons systems, ammunition or lethal munitions.

Our proposed model will make it possible to pool capital from member countries without reducing their fiscal space. In turn, it will help mobilise private capital, reduce the cost of financing and provide long-term solutions at better rates. It will enable us to move fast and decisively - key amid current ruptures in the world order.

As we prepare for the forthcoming Nato summit in Ankara in July, we are committed to helping allies rally around a defence bank ready to deploy capital within a 12-month timeframe. Canada and Luxembourg are proud to be leading this effort. We share a commitment to multilateralism. Both our countries host major financial centres with expertise in cross-border solutions and the backing of triple A rated sovereigns.

Joining the DSRB at the moment of its founding is an unequivocal signal of cohesion among allies who seek to amplify their collective financial firepower. Founding members will get to shape the bank's governance and norms, as well as to frame its initial operating arrangements. This will contribute to building the future of our collective defence for years to come.

We believe this can be another milestone in the Nato partnership, opening a new era in transatlantic relations. Together, we will turn financial guarantees into security guarantees, and finance into deterrence.