The control of transposable element (TE) activity in germ cells provides genome integrity over generations. A distinct small RNA-mediated pathway utilizing Piwi-interacting RNAs (piRNAs) suppresses TE expression in gonads of metazoans. In the fly, primary piRNAs derive from so-called piRNA clusters, which are enriched in damaged repeated sequences. These piRNAs launch a cycle of TE and piRNA cluster transcript cleavages resulting in the amplification of piRNA and TE silencing. Using genome-wide comparison of TE insertions and ovarian small RNA libraries from two Drosophila strains, we found that individual TEs inserted into euchromatic loci form novel dual-stranded piRNA clusters. Formation of the piRNA-generating loci by active individual TEs provides a more potent silencing response to the TE expansion. Like all piRNA clusters, individual TEs are also capable of triggering the production of endogenous small interfering (endo-si) RNAs. Small RNA production by individual TEs spreads into the flanking genomic regions including coding cellular genes. We show that formation of TE-associated small RNA clusters can down-regulate expression of nearby genes in ovaries. Integration of TEs into the 3' untranslated region of actively transcribed genes induces piRNA production towards the 3'-end of transcripts, causing the appearance of genic piRNA clusters, a phenomenon that has been reported in different organisms. These data suggest a significant role of TE-associated small RNAs in the evolution of regulatory networks in the germline.