Assuming it stores the backup on the device temporarily (or permanently), that message seems to indicate that there is not enough room to do so. I'm not sure how you arrived at your conclusion.
What an interesting design.
It would first make it extremely annoying to restore from backup, once the free space on the phone was less than the size of the backup
And then, once the users had been trained- "To restore, first you delete all your user data files- No worries, the backup will have them", you get to the point where the phone storage is almost full, you take a backup, try to restore it- Not enough space, delete all user files... and still not enough space. You end up with a backup it's impossible to restore, and a loss of data on the phone
(Yes, to be fair, you probably need some files that don't compress well for the size of backup plus size of bare bones OS to be greater than that of local storage... but still, why would you do such a thing in the first place?)