By 2029, the core defense budget is slated to rise to 3.5 percent of GDP, with a further 1.5 percent earmarked for security and resilience infrastructure – a total of around €216 billion annually, a good €130 billion more than today. Enough has been said about the historical significance of this shift in policy. The economically interesting question now is: What happens when demand explodes but supply cannot keep pace?
When demand grows faster than supply
The economic answer is obvious, but the political consequences are underestimated: longer delivery times, rising prices, and growing import dependency. According to SIPRI, around 64 percent of European arms procurement still comes from the USA. Such dependency doesn't disappear within a few fiscal years, and political will alone doesn't create production capacity.
Across NATO, arms inflation is around six to ten percent annually, significantly higher than the general inflation rate. If the German defense budget increases nominally by ten to fifteen percent, this translates to only three to six percent more capacity in real terms. More money, therefore, does not automatically mean greater deterrence: those who confuse budget lines with quantities overestimate the impact of larger budgets.
Capital markets priced this in early. When the German Bundestag exempted defense spending from the debt brake in March 2025, yields on ten-year German government bonds rose by around 40 basis points within a few days. This was not a vote of no confidence in Germany's creditworthiness, but a repricing of uncertainty. Risks can be calculated and insured. Uncertainty cannot.
The bottleneck is therefore not money, but production: Without additional capacity, increased demand primarily drives up prices – not the quantities of ammunition, drones or spare parts.
The bottleneck lies in the middle class.
The bottleneck lies deep within the supply chains. Not with the large system integrators with access to capital markets, but with thousands of medium-sized suppliers: specialists in electronics, precision parts, and materials, often with dual-use businesses. They have to pre-finance personnel, materials, certifications, and new production lines – often months before the first order brings in any revenue.
Until recently, banks' hesitancy was often explained by ESG factors. But that's too simplistic. Neither Berlin nor Brussels prohibits defense financing. The problem is more traditional: many smaller and younger suppliers lack external ratings, have little collateral, and little equity. The issue isn't a lack of political demand, but rather a lack of bankable creditworthiness that meets Basel regulations.
The KfW-ifo credit hurdle illustrates just how limited the financing options are for SMEs across all sectors: In the second quarter of 2026, 40.5 percent of SMEs negotiating loans reported restrictive banking behavior – a record since the survey began in 2017. For banks, loans to small, capital-intensive, and often unvalued defense companies are also expensive: They tie up regulatory capital and concentrate risks on a few programs.
This creates a paradox: what is strategically essential remains economically unattractive for individual banks. The problem is therefore less a lack of trust than an incorrect allocation of risks. This is precisely where blended finance comes in.
What Blended Finance really means
Blended finance sounds more technical than it is. It refers to the targeted combination of public and private capital: the state assumes, through guarantees and risk sharing, precisely that portion of the risk that has previously prevented commercial financing. Public capital is not intended to replace private capital, but rather to mobilize it. A euro can only be spent once, unless it is leveraged.
Several instruments are available today for this purpose. SAFE primarily strengthens the demand side through favorable EU loans; KfW, the German Defense Fund, and the investment vehicle for defense companies announced in the new startup and scaleup strategy are intended to further support the supply side. However, what is still lacking are guarantee programs tailored to defense SMEs: with higher liability exemptions, larger loan volumes, and, above all, geographical flexibility. Germany's security doesn't end at the Elbe River – the supply chains of German SMEs naturally extend to the Baltic states and far beyond.
This is precisely where the Defence, Security and Resilience Bank (DSRB) comes in. As a new multilateral bank, it will facilitate both public and private financing. For Germany itself, favorable government loans would hardly be decisive due to its own high credit rating. The benefit would lie instead with its partner states: around two-thirds of NATO allies could refinance more cheaply – and thus more easily purchase from German manufacturers. The private sector is even more important. In addition to direct loans and equity instruments, the DSRB will relieve the burden on commercial banks through qualified guarantees. If credit risks are effectively transferred to the multilateral balance sheet, the regulatory risk weights of covered tranches will decrease – and with them, the hurdle for new loans to defense companies and deep-market suppliers.
The model itself is not new, but the mandate is: the World Bank, EIB, and EBRD have been operating with similar leverage mechanisms for decades, though without a dedicated mandate for genuine defense and security projects. Member states receive ownership and voting rights in exchange for capital contributions; the DSRB can then leverage this capital many times over through its own AAA-rated bonds. Liabilities remain on its balance sheet – thus precluding joint liability among member states.
Why Germany is in demand
Whether Germany benefits from such a multilateral instrument is a decision it must make for itself. It is not yet among the publicly known founding states. This is relevant because only companies from member states, whose capital contributions make the leverage effects possible in the first place, benefit from preferential procurement, direct loans, and guarantees. At the same time, defense spending only sustainably strengthens the domestic economy if it actually flows into production and supply chains instead of being absorbed by imports or lost to a few large systems integrators.
At the Centre for Economic Security, we assume that the DSRB can achieve this even under conservative assumptions. Germany would be a natural beneficiary: If it reaches a balance sheet total of €100 billion within ten years, for example, more than €16 billion could flow into German industry – through supply chain financing and procurement contracts from other member states. The financial commitment for Germany would be manageable: The necessary capital contribution would likely be up to €1.5 billion and, according to IMF standards, is considered an asset acquisition, payable in installments and creditable towards the NATO target. In addition, there would be around €6 billion in callable capital – a contingent liability that has never been called upon in the history of multilateral development banks.
From an industrial policy perspective, German membership would also make sense because Germany has one of the deepest-rooted, medium-sized supplier networks in Europe. If defense financing becomes more multilaterally organized in the future, these medium-sized businesses, not just the large system integrators, should have access to the emerging financing ecosystem. Moreover, it's clear: those who co-found the organization set the rules. Those who join later inherit them. This isn't a plea for membership at any cost. But it is an argument against preempting the decision through hesitation. The next, multilateral phase of this paradigm shift will therefore be decided not only in the German federal budget but also in the balance sheets of German banks. Orders create demand. Financing creates capacity. Whether the DSRB is the best instrument for this, it will have to prove itself, as it will with any new multilateral organization. What is clear today, however, is that Germany cannot afford to leave this question to others.
Dr. Rebecca Harding is an independent trade economist and Chief Executive of the Centre for Economic Security in London. Her latest book, "The World at Economic War: How to Rebuild Security in a World of Weaponised Economics," was named one of the Best Books in Economics of 2025 by the Financial Times.
2Said D. Werner is a Research Affiliate at the Massachusetts Institute of Technology (MIT) and Affiliate Director of the MIT Murray Lab for Deep Tech & Geopolitics, as well as a Mercator Fellow on International Affairs, where he focuses on multilateral financing models for defense and innovation.