The capacity of LGUs is central to the success of the MDLF and will be a major influence on the MDLF operation. Participating LGUs will be responsible for consultations with local communities and citizens in the assessment of priority needs, the submission of program proposals based on standardized forms, and the implementation of their approved programs. In addition, an institutional development component will be designed and implemented to raise the capacity of LGUs to design, implement and evaluate activities funded by the MDLF.

Though MDLF’s funding to LGUs will start in the form of grants, its medium and long term objective is to strengthen LGUs financial capacity so that many of LGUs will become creditworthy and will be able to benefit from loans through MDLF for the financing of the local infrastructure and services. From this perspective, MDLF’s objective in the future would be to play the role of a financial intermediary for LGUs in Palestine
The MDLF will provide and fund institutional development programs to strengthen LGUs capacity in designing and implementing activities funded by donors. The MDLF will facilitate the implementation of policies and strategies adopted by the Ministry of Local Government (MOLG) to reform the local government (LG) system in Palestine

These strategies include the following actions:

• The MDLF, through the MOLG will encourage small LGUs and Micro Regional Planning Committees to join Joint Service Councils or to amalgamate with themselves to form a municipality to maximize their benefits from MDLF institutional building activities, particularly in the project planning and management areas, and become feasible for funding;
• The MDLF will use its programs to help the LGUs to integrate more of the services provided by the individual LGUs in higher regional entities;
• Almost all the LGUs are working without systematic development plans. MDLF will address this issue by assisting in the preparation of sound development plans for LGUs along with the needed capacity building activities.
• The existing laws, by-laws and regulations in the LG system should be respected with an attempt to improve and upgrade the regulations and guidelines of these laws.