Councillors were told that the development would need to generate income in order to repay the £22m loan which would finance the scheme, and therefore was not viable.
Developers Wrenbridge and Buccleuch Property plan to demolish the existing former Argos building on Newborough and replace it with ground-floor retail units and accommodation for 50 in-training NHS doctors and nurses from Scarborough Hospital and 150 university students on the upper levels.
Many of the opponents against the scheme have called for a public square instead.
At the full council meeting on Monday, Cllr Liz Colling said: "In order for us to fund the Argos development we would be borrowing money from the Public Works Loan Board.
"In order to pay that back there has to be an income generated from the project and the rent from this development will pay back the loan plus the interest.
"If there was to be a public square there, there is no income from that public square. So, we could not borrow the money."
Cllr Colling said Historic England would object to knocking down the entire row of St Helen’s Square that faces the Market Hall to make way for a large public square, and branded the idea as "a myth".
Concerns had been raised that a worldwide increase in the cost of building materials would cause the controversial project to run over budget.
Cllr Colling confirmed that if the cost of works would exceed the £22m loan, any decision to move ahead would have to come back to full council for approval.
At a meeting of the council’s Places and Futures Overview and Scrutiny Committee last week, councillors warned that the council could be left in ownership of a building that it cannot afford to develop.
Scarborough Council is contractually obliged to purchase the building, which is believed would cost in the region of £1m, from Buccleuch Property Ltd once three conditions are met, one of which is receiving planning permission. Currently, none of the conditions has been met.
However, the council would not know the final cost of the proposed works until a viability report is conducted in early 2022, after the building’s plans have been drawn up and the purchase completed.
Councillors were told that there would be no money remaining to develop the site if it exceeds the £22m loan, and work would not progress at that stage.
Addressing parking concerns in the area, Cllr Colling said students "will be told very clearly there is no parking facility for them at this site" and that the NHS has approached the council over contract parking for its staff.