The coupled mechanics of fluid-filled granular media controls the behavior of many natural systems such as saturated soils, fault gouge, and landslides. The grain motion and the fluid pressure influence each other: It is well established that when the fluid pressure rises, the shear resistance of fluid-filled granular systems decreases, and as a result catastrophic events such as soil liquefaction, earthquakes, and accelerating landslides may be triggered. Alternatively, when the pore pressure drops, the shear resistance of these systems increases. Despite the great importance of the coupled mechanics of grains-fluid systems, the basic physics that controls this coupling is far from understood. We developed a new multi-scaled model based on the discrete element method, coupled with a continuum model of fluid pressure, to explore this dynamical system. The model was shown recently to capture essential feedbacks between porosity changes arising from rearrangement of grains, and local pressure variations due to changing pore configurations. We report here new results from numerical experiments of a continuously shearing layer of circular two-dimensional grains, trapped between two parallel rough boundaries. The experiments use a fixed confining stress on the boundary walls, and a constant velocity applied to one of the boundaries, as if this system was the interior of a sliding geological fault filled with 'fault gouge'. In addition, we control the layer permeability and the drainage boundary conditions. This paper presents modeling results showing that the localization of shear (into a narrow shear band within the shearing layer) is strongly affected by the presence of fluids. While in dry granular layers there is no preferred position for the onset of localization, drained systems tend to localize shear on their boundary. We propose a scaling argument to describe the pressure deviations in a shear band, and use that to predict the allowable positions of shear localizations as a function of the fault and gouge properties.