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Promising results of pancreatic islet transplantation to treat type 1 diabetes mellitus, combined with severe shortage of donor pancreata, have spurred efforts to generate pancreatic islet-like cells and insulin-producing β-cells from various progenitor populations. In this study, we show for the first time that multipotent nestin-positive stem cells selected from rat bone marrow can be differentiated into pancreatic ductal and insulin-producing β-cells in vitro. We report an effective multistep protocol in a serum-free system, which could efficiently induce β-cell differentiation from multipotent nestin-positive bone marrow stem cells. To enhance the induction and differentiation toward pancreatic lineage we used trichostatin A, an important regulator of chromatin remodeling, and 5-aza 2′ deoxycytidine, an inhibitor of DNA methylase. All-trans retinoic acid was then utilized to promote pancreatic differentiation. We sequentially induced important transcription factor genes, such as Pdx1, Ngn3, and Pax6, following the in vivo development timeline of the pancreas in rats. Furthermore, in the final stage with the presence of nicotinamide, the induced cells expressed islet and ductal specific markers. The differentiated cells not only expressed insulin and glucose transporter 2, but also displayed a glucose-responsive secretion of the hormone. Our results delineate a new model system to study islet neogenesis and possible pharmaceutical targets. Nestin-positive bone marrow stem cells may be therapeutically relevant for β-cell replacement in type 1 diabetes.