Nonalcoholic fatty liver disease (NAFLD) is a common liver disease that ranges from simple steatosis to nonalcoholic steatohepatitis (NASH). So far, the underlying mechanism remains poorly understood. Here, we show that hepatic carboxylesterase 2 (CES2) is markedly reduced in NASH patients, diabetic db/db mice, and high‐fat diet (HFD)‐fed mice. Restoration of hepatic CES2 expression in db/db or HFD‐fed mice markedly ameliorates liver steatosis and insulin resistance. In contrast, knockdown of hepatic CES2 causes liver steatosis and damage in chow‐ or Western diet‐fed C57BL/6 mice. Mechanistically, we demonstrate that CES2 has triglyceride hydrolase activity. As a result, gain of hepatic CES2 function increases fatty acid oxidation and inhibits lipogenesis, whereas loss of hepatic CES2 stimulates lipogenesis by inducing endoplasmic reticulum stress. We further show that loss of hepatic CES2 stimulates lipogenesis in a sterol regulatory element‐binding protein 1 (SREBP‐1)‐dependent manner. Finally, we show that hepatocyte nuclear factor 4 alpha (HNF‐4α) plays a key role in controlling hepatic CES2 expression in diabetes, obesity, or NASH. Conclusion: CES2 plays a protective role in development of NAFLD. Targeting the HNF‐4α/CES2 pathway may be useful for treatment of NAFLD. (Hepatology 2016;63:1860‐1874)