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UPDATE 1-Italy's Monti says ESM should aid banks directly

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* Banking union unfolds with plan to give ECB supervisorypowers

* Move expected to pave way for euro zone rescue fund tohelp banks

* Italy's Monti says ESM should rapidly be allowed givedirect aid

(Adds background, detail)

BRUSSELS, Oct 11 (Reuters) - Italy's Prime Minister MarioMonti said on Thursday it was essential the euro zone'sfinancial rescue mechanism be allowed to directly assist banksrather than giving aid through governments.

"Once the single supervisory mechanism is established theESM should be rapidly given the possibility to recapitalisebanks directly," Monti said in remarks prepared for delivery ata dinner hosted by the Friends of Europe think-tank on Thursday.

"This is important to separate existing and future bankingand sovereign liabilities," he said in the text, adding thatthere also needed to be agreement on common rules governing bankdeposits as well as the resolution of the banking crisis.

Monti's remarks come as EU countries seek to build a bankingunion to restore confidence in an industry that has beenbattered by crisis over more than five years.

It has three major steps: the ECB takes over monitoring eurozone banks and others that sign up; a single fund is created toclose down and settle the debts of failed banks; and acomprehensive scheme to protect savers' deposits is established.

As well as building the foundation for better control ofbanks, the new supervision is important because it should allowthe euro zone's rescue fund, the European Stability Mechanism(ESM), to directly inject much-needed capital into banks, suchas those in Spain.

This pledge, made by euro zone leaders in June, looked atrisk of unravelling, however, after Germany, the Netherlands andFinland drew a distinction between future banking problems and"legacy" difficulties - which could mean that problem banks inSpain and Ireland remain the states' responsibility.

(Reporting By Luke Baker and John O'Donnell; editing by AndrewRoche)

((john.odonnell@thomsonreuters.com)(+32 2 287 68 17 or +32 47569 15 89)(Reuters Messaging:john.odonnell.thomsonreuters.com@reuters.net))

Keywords: EU MONTI/BANKS