Cystatin M/E is a high affinity inhibitor of the asparaginyl endopeptidase legumain, and we have previously reported that both proteins are likely to be involved in the regulation of stratum corneum formation in skin. Although cystatin M/E contains a predicted binding site for papain-like cysteine proteases, no high affinity binding for any member of this family has been demonstrated so far. We report that human cathepsin V (CTSV) and human cathepsin L (CTSL) are strongly inhibited by human cystatin M/E. Kinetic studies show that Ki values of cystatin M/E for the interaction with CTSV and CTSL are 0.47 and 1.78 nM, respectively. On the basis of the analogous sites in cystatin C, we used site-directed mutagenesis to identify the binding sites of these proteases in cystatin M/E. We found that the W135A mutant was rendered inactive against CTSV and CTSL but retained legumain-inhibiting activity. Conversely, the N64A mutant lost legumain-inhibiting activity but remained active against the papain-like cysteine proteases. We conclude that legumain and papain-like cysteine proteases are inhibited by two distinct non-overlapping sites. Using immunohistochemistry on normal human skin, we found that cystatin M/E co-localizes with CTSV and CTSL. In addition, we show that CTSL is the elusive enzyme that processes and activates epidermal transglutaminase 3. The identification of CTSV and CTSL as novel targets for cystatin M/E, their (co)-expression in the stratum granulosum of human skin, and the activity of CTSL toward transglutaminase 3 strongly imply an important role for these enzymes in the differentiation process of human epidermis.