* Sees little scope for bad surprises in asset quality review
* Says must tackle problem of sovereign-bank loop
* Says must move trading onto supervised exchanges (Adds Koenig comments on government bonds, benchmarks)
FRANKFURT, Jan 16 German banks may face a capital shortfall in stress tests on the sector over the coming months, the head of the country's financial market watchdog Bafin said on Thursday.
"Depending on how the scenarios and assumptions are set up, the (stress) test could unearth additional capital needs at some banks," the financial regulator's President Elke Koenig said in the text of a speech.
She added, however, she was confident the European Central Bank's asset quality review, which will precede the stress tests, held little scope for unpleasant surprises.
Both assessments of banks' health were essential to allow a proper start to the ECB's takeover of banking supervision in the euro area from November, she said.
"Both must be stringent but we have to proceed with a sense of proportion," she said.
Koenig also said regulators needed to change the preferential treatment given to government bonds, which was encouraging banks to invest in them and strengthening the inter-twining of banks and sovereigns, also known as the "doom loop".
Turning to efforts to reform financial benchmarks in interest rates, money markets, precious metals and foreign exchange markets following rigging scandals, Koenig said a proposal made by the European Commission was a step in the right direction but relied too heavily on self-policing.
"Market transparency and market control are only possible if huge streams of data can be centralised," she said.
"You therefore have to move as much trading as possible on these markets to transparent, directly or indirectly supervised exchanges," she said. (Reporting by Jonathan Gould, Eva Taylor and Thomas Atkins; Editing by Ludwig Burger and David Evans)