Presenilin proteins have been implicated both in developmental signalling by the cell-surface protein Notch and in the pathogenesis of Alzheimer's disease. Loss of presenilin function leads to Notch/lin-12-like mutant phenotypes in Caenorhabditis elegans and to reduced Notch1 expression in the mouse paraxial mesoderm. In humans, presenilins that are associated with Alzheimer's disease stimulate overproduction of the neurotoxic 42-amino-acid beta-amyloid derivative (Abeta42) of the amyloid-precursor protein APP. Here we describe loss-of-function mutations in the Drosophila Presenilin gene that cause lethal Notch-like phenotypes such as maternal neurogenic effects during embryogenesis, loss of lateral inhibition within proneural cell clusters, and absence of wing margin formation. We show that presenilin is required for the normal proteolytic production of carboxy-terminal Notch fragments that are needed for receptor maturation and signalling, and that genetically it acts upstream of both the membrane-bound form and the activated nuclear form of Notch. Our findings provide evidence for the existence of distinct processing sites or modifications in the extracellular domain of Notch. They also link the role of presenilin in Notch signalling to its effect on amyloid production in Alzheimer's disease.