Why might a bank decline a loan for a new sole proprietor based on debt ratio?

A high debt ratio is a significant factor for banks when considering loan applications. This ratio compares the amount of debt a business has to its total assets. A high debt ratio indicates that a large portion of the business's assets is financed through debt, which can be a red flag for lenders. It suggests that the business may struggle to cover its financial obligations, increasing the risk of default.

Banks are in the business of managing risk, and a high debt ratio implies that the sole proprietor already has a heavy financial burden. If the business does not generate sufficient revenue to cover its debt payments, it could face financial difficulties, which would jeopardize the bank's loan repayment.

In this scenario, although other factors like a poorly written business plan, lack of experience, or unrealistic revenue predictions could play a role in a bank's decision-making, the debt ratio specifically provides a quantitative measure of financial health that directly influences lending decisions. A low debt ratio would generally be more favorable, reflecting a lower risk to the lender.