Limited information is available on the cellular interactions between regulatory T (T-reg) cells and mesenchymal stem cells (MSCs). In particular, a direct effect of MSCs on the survival and proliferation of T-reg cells has not been demonstrated. We investigated the effects of MSCs on effector T (T-eff) cells and T-reg cells, and the molecular mechanisms involved in the distinct regulation of these two cell populations by MSCs in vivo and in vitro. We show that MSCs are capable of selectively suppressing T-eff cells and fostering the generation of T-reg cells. T-eff cells, but not T-reg cells, fail to respond to IL-2 and undergo profound apoptosis in the presence of MSCs. The differential regulations of these two T cell subsets by MSCs are associated with their distinct expressions of CD25, with MSCs specifically reducing the expression of CD25 on T-eff and sparing T-reg cells intact. In vivo, the administration of MSCs significantly delays the rejection of allogeneic islet grafts in adaptive transferred recipients by favouring the induction of T-reg cells. In this model, MSCs inhibit the proliferation and development of alloreactive T-eff but potently enhance the induction of T-reg cells. We demonstrate that MSCs are capable of regulating T-eff and T-reg cells differentially in vitro. MSCs inhibit T-eff cells by inducing apoptosis and impairing the proliferative response to IL-2 in T-eff cells, but favour the survival and expansion of T-reg cells. This result is further demonstrated in mice that have undergone allogeneic islet transplantation, in which MSCs suppress alloreactive T-eff cells while favouring the induction of T-reg cells, thus protecting the islet allografts from rejection.