In this paper, we propose a new method for fault detection and isolation based on observer and adaptive observers. Each adaptive observer estimates the state variables and one of the parameters of the monitored system. The algorithms for both residual generation and evaluation are presented in detail. The proposed method is applicable to all non-linear dynamic systems for which the required observer and adaptive observers can be designed. The presentation is illustrated throughout the paper by a simulation example, a controlled satellite. Copyright © 2000 John Wiley & Sons, Ltd.