The capability approach has recently been used in Australian Indigenous policy formation. Of particular note is how it has been used in some instances to justify current paternalistic and directive policies for Indigenous Australians. These include behavioural conditionalities on state support and income management—policy apparatuses that aim to create individual responsibility and to re-engineer the social norms of Indigenous people. This interpretation of the capability approach is at odds with the writings of Sen, because it overlooks the core concepts of freedom, agency and pluralism. To examine this tension, this paper reviews the contestation between capability scholars and commentators on Indigenous policy, paying particular attention to four areas: human capability vs human capital, deficit discourse, individual responsibility, and the ends and means of policy. Finally, to reinvigorate the capability approach in Australian Indigenous policy, six areas are suggested in which the capability approach could be used in the future.