Pancreatic islet beta-cell dysfunction is a signature feature of Type 2 diabetes pathogenesis. Consequently, knowledge of signals that regulate beta-cell function is of immense clinical relevance. Transforming growth factor (TGF)-beta signaling plays a critical role in pancreatic development although the role of this pathway in the adult pancreas is obscure. Here, we define an important role of the TGF-beta pathway in regulation of insulin gene transcription and beta-cell function. We identify insulin as a TGF-beta target gene and show that the TGF-beta signaling effector Smad3 occupies the insulin gene promoter and represses insulin gene transcription. In contrast, Smad3 small interfering RNAs relieve insulin transcriptional repression and enhance insulin levels. Transduction of adenoviral Smad3 into primary human and non-human primate islets suppresses insulin content, whereas, dominant-negative Smad3 enhances insulin levels. Consistent with this, Smad3-deficient mice exhibit moderate hyperinsulinemia and mild hypoglycemia. Moreover, Smad3 deficiency results in improved glucose tolerance and enhanced glucose-stimulated insulin secretion in vivo. In ex vivo perifusion assays, Smad3-deficient islets exhibit improved glucose-stimulated insulin release. Interestingly, Smad3-deficient islets harbor an activated insulin-receptor signaling pathway and TGF-beta signaling regulates expression of genes involved in beta-cell function. Together, these studies emphasize TGF-beta/Smad3 signaling as an important regulator of insulin gene transcription and beta-cell function and suggest that components of the TGF-beta signaling pathway may be dysregulated in diabetes.