Coastal lagoons provide key habitat for a wide range of biota but are often degraded by intense urbanization pressures. Insectivorous bats use these highly productive ecosystems and are likely to be impacted by their decline in quality. We compared bat activity and richness and invertebrate biomass and richness across a gradient of lagoon quality (9 lagoons) in the Greater Sydney region, Australia to determine the extent to which bats and their prey were impacted by lagoon degradation. Bats were more diverse and 19 times more active at higher quality lagoons. The trawling bat, Myotis macropus, was absent from all low quality lagoons, but these lagoons were used by other species such as Miniopterus schreibersii oceanensis. Invertebrate richness and biomass did not differ significantly across lagoon quality. We examined potential mechanisms of insectivorous bat decline at degraded lagoons by measuring toxic metal concentrations in bat fur, invertebrates and sediment. Lead and zinc were detected at environmentally significant levels in the sediments of lower quality lagoons. Furthermore, lead concentrations were 6 times the lowest observable adverse effects level for small mammals in the hair of one individual M. macropus. The present study demonstrates that coastal lagoons support a rich bat community, but ongoing development and pollution of these habitats is likely to negatively impact on insectivorous bat species, especially trawling species.