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

* Banking union unfolds with plan to give ECB supervisory powers

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

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

(Adds background, detail)

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

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

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

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

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

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

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

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

((john.odonnell@thomsonreuters.com)(+32 2 287 68 17 or +32 475 69 15 89)(Reuters Messaging: john.odonnell.thomsonreuters.com@reuters.net))