In American city, possesses capital (5)
I believe the answer is:
lhasa
'capital' is the definition.
(Lhasa is an example)
'in american city possesses' is the wordplay.
'in' is an insertion indicator.
'american city' becomes 'LA' (abbreviation for Los Angeles).
'possesses' becomes 'has' ('have' can be a synonym of 'possess').
'la' placed around 'has' is 'LHASA'.
(Other definitions for lhasa that I've seen before include "Tibetan holy city" , "Tibetan dog breed" , "The Forbidden City in Tibet" , "Asian capital" , "Group; stripe" .)