Obesity and type II diabetes are closely linked metabolic syndromes that afflict >100 million people worldwide. Although protein tyrosine phosphatase 1B (PTP1B) has emerged as a promising target for the treatment of both syndromes, the discovery of pharmaceutically acceptable inhibitors that bind at the active site remains a substantial challenge. Here we describe the discovery of an allosteric site in PTP1B. Crystal structures of PTP1B in complex with allosteric inhibitors reveal a novel site located ∼20 Å from the catalytic site. We show that allosteric inhibitors prevent formation of the active form of the enzyme by blocking mobility of the catalytic loop, thereby exploiting a general mechanism used by tyrosine phosphatases. Notably, these inhibitors exhibit selectivity for PTP1B and enhance insulin signaling in cells. Allosteric inhibition is a promising strategy for targeting PTP1B and constitutes a mechanism that may be applicable to other tyrosine phosphatases.