Pancreas stem cells are a potential source of insulin-producing β cells for the therapy of diabetes. In adult tissues the 'side population' (SP) of cells that effluxes the DNA binding dye Hoechst 33342 through ATP-binding cassette transporters has stem cell properties. We hypothesised therefore that the SP would expand in response to β cell injury and give rise to functional β cells. SP cells were flow sorted from dissociated pancreas cells of adult mice, analysed for phenotype and cultured with growth promoting and differentiation factors before analysis for hormone expression and glucose-stimulated insulin secretion. SP cell number and colony forming potential (CFP) increased significantly in models of type diabetes, and after partial pancreatectomy, in the absence of hyperglycaemia. SP cells, ∼1% of total pancreas cells at 1 week of age, were enriched >10-fold for CFP compared to non-SP cells. Freshly isolated SP cells contained no insulin protein or RNA but expressed the homeobox transcription factor Pdx1 required for pancreas development and β cell function. Pdx1, along with surface expression of CD326 (Ep-Cam), was a marker of the colony forming and proliferation potential of SP cells. In serum-free medium with defined factors, SP cells proliferated and differentiated into islet hormone-expressing cells that secreted insulin in response to glucose. Insulin expression was maintained when tissue was transplanted within vascularised chambers into diabetic mice. SP cells in the adult pancreas expand in response to β cell injury and are a source of β cell progenitors with potential for the treatment of diabetes.