Genome-wide association studies revealed that common non-coding variants in MTNR1B (encoding melatonin receptor 1B, also known as MT2) increase type 2 diabetes (T2D) risk1,2. Although the strongest association signal was highly significant (P<10−20), its contribution to T2D risk was modest (odds ratio, OR~1.10-1.15)1-3. We performed large-scale exon resequencing in 7,632 Europeans including 2,186 T2D patients and identified 40 non-synonymous variants, including 36 very rare variants (minor allele frequency, MAF<0.1%) associated with T2D (OR=3.31[1.78;6.18]95%); P=1.64×10−4. A four-tier functional investigation of all 40 mutants revealed that 14 were non-functional and rare (MAF<1%); four were very rare with complete loss of melatonin binding and signaling capabilities. Among the very rare variants, the partial or total loss-of-function variants, but not the neutral ones, contributed to T2D (OR=5.67[2.17;14.82]95%; P=4.09×10−4). Genotyping the four complete loss-of-function variants in 11,854 additional individuals revealed their association with T2D risk (Ncases=8,153/Ncontrols=10,100; OR=3.88[1.49;10.07]95%; P=5.37×10−3). This study establishes a firm functional link between MTNR1B and T2D risk.