OBJECTIVE: We evaluated the role of fatty liver in the alteration of insulin sensitivity and β-cell function in two groups of obese adolescents, differing in hepatic fat content (hepatic fat fraction HFF) but with similar intrabdominal intramyocellular lipid content (IMCL) and overall degree of obesity. RESEARCH DESIGN AND METHODS: We studied 23 obese adolescents with high HFF (HFF >5.5%) and 20 obese adolescents with low HFF (HFF <5.5%), matched for age, Tanner stage, BMI z score, and percentages of body fat, visceral fat, and IMCL. All subjects underwent an oral glucose tolerance test and a two-step hyperinsulinemic-euglycemic clamp, magnetic resonance imaging and ¹H nuclear magnetic resonance to assess abdominal fat distribution, HFF, and IMCL, respectively. RESULTS: The high HFF group showed significantly lower whole-body insulin sensitivity index (P = 0.001) and estimates of insulin secretion (P = 0.03). The baseline hepatic glucose production (EGP) rate was not different between the two groups. Suppression of EGP was significantly lower (P = 0.04) in the high HFF group during low-dose insulin; no differences were observed during the second step. Baseline fatty acids, glycerol concentrations, and clamp suppression of glycerol turnover did not differ between the groups. During the second step, the glucose disposal rate was significantly lower (P = 0.01) in the high HFF group. CONCLUSIONS: Fatty liver, independent of visceral fat and IMCL, plays a central role in the insulin-resistant state in obese adolescents.