Intrahepatic bile ducts (IHBDs) are indispensable for transporting bile secreted from hepatocytes to the hepatic duct. The biliary epithelial cells (BECs) of the IHBD arise from bipotent hepatoblasts around the portal vein, suggesting the portal mesenchyme is essential for their development. However, except for Notch or Activin/TGF‐β signaling molecules, it is not known which molecules regulate IHBD development. Here, we found that FGF receptors and BMP4 are specifically expressed in the developing IHBD and the hepatic mesenchyme, respectively. Using a mesenchyme‐free culture of liver bud, we showed that bFGF and FGF7 induce the hepatoblasts to differentiate into BECs, and that BMP4 enhances bFGF‐induced BEC differentiation. The extracellular matrix (ECM) components in the hepatic mesenchyme induced BEC differentiation. Forced expression of a constitutively active form of the FGF receptor partially induced BEC differentiation markers in vivo. These data strongly suggest that bFGF and FGF7 promote BEC differentiation cooperatively with BMP4 and ECMs in vivo. Developmental Dynamics 237:1268‐1283, 2008. © 2008 Wiley‐Liss, Inc.