Destruction of li by proteolysis is required for MHC class II molecules to bind antigenic peptides, and for transport of the resulting complexes to the cell surface. The cysteine protease cathepsin S is highly expressed in spleen, lymphocytes, monocytes, and other class II-positive cells, and is inducible with interferon-gamma. Specific inhibition of cathepsin S in B lymphoblastoid cells prevented complete proteolysis of li, resulting in accumulation of a class II-associated 13 kDa li fragment in vivo. Consequently, the formation of SDS-stable complexes was markedly reduced. Purified cathepsin S, but not cathepsin B, H, or D, specifically digested li from alpha beta li trimers, generating alpha beta-CLIP complexes capable of binding exogenously added peptide in vitro. Thus, cathepsin S is essential in B cells for effective li proteolysis necessary to render class II molecules competent for binding peptides.