Associated with innovation in both democratic practice and service design, neighbourhoods are high on policy agendas across Europe. Drawing upon classic debates about size and devolution, the article identifies four distinct rationales for neighbourhood governance: civic, social, political and economic. In England, the 'new localism' agenda gets near to developing a comprehensive case for neighbourhood governance, drawing upon all four rationales. Options for institutional design are explored with reference to four ideal types: (1) neighbourhood empowerment; (2) neighbourhood partnership; (3) neighbourhood government; (4) and neighbourhood management. Key challenges for neighbourhood governance are analysed in terms of capacity, competence, diversity and equity. The article argues that the classic democracy/capacity trade-off associated with small units needs to be re-thought in the context of the 'new governance' (multi-level, multi-actor and e-enabled). Rather than confronting one big trade-off, institutional designers face a series of questions about the underlying purposes and priorities of neighbourhood governance.