Bone marrow stromal cells (MSCs) are multipotent stem cells that have the potential to differentiate into bone, cartilage, fat and muscle. We now demonstrate that MSCs can be induced to differentiate into cells with Schwann cell characteristics, capable of eliciting peripheral nervous system regeneration in adult rats. MSCs treated with beta-mercaptoethanol followed by retinoic acid and cultured in the presence of forskolin, basic-FGF, PDGF and heregulin, changed morphologically into cells resembling primary cultured Schwann cells and expressing p75, S-100, GFAP and O4. The MSCs were genetically engineered by transduction with retrovirus encoding green fluorescent protein (GFP), and then differentiated by treatment with factors described above. They were transplanted into the cut ends of sciatic nerves, which then responded with vigorous nerve fibre regeneration within 3 weeks of the operation. Myelination of regenerated fibers by GFP-expressing MSCs was recognized using confocal and immunoelectron microscopy. The results suggest that MSCs are able to differentiate into myelinating cells, capable of supporting nerve fibre re-growth, and they can therefore be applied to induce nerve regeneration.