The majority of obese insulin resistant individuals maintain normoglycaemia because their islet β-cells compensate with insulin hypersecretion. Type 2 diabetes develops in subjects with β-cells that are susceptible to failure. Mechanisms of β-cell compensation and failure are poorly understood. Endoplasmic reticulum (ER) stress has been implicated in β-cell dysfunction and death in type 2 diabetes. ER stress activates a signalling cascade known as the unfolded protein response (UPR), which has roles both to facilitate adaptation to ER stress through the upregulation of ER chaperones and folding enzymes and, paradoxically, to activate apoptosis via deleterious UPR signalling if the stress is too severe or prolonged. Recent findings suggest that upregulation of the adaptive UPR is linked with β-cell compensation and protection against obesity-associated diabetes. Conversely, in genetically susceptible β-cells, suppression of ER adaptation and loss of β-cell differentiation underlies β-cell failure and progression to diabetes. Factors leading to failure of ER adaptation include chronic hyperglycaemia and inflammation. This knowledge is critically important to understanding the mechanisms responsible for the switch from β-cell compensation to failure in type 2 diabetes.