* Market sources say banks tap BuBa for bonds
* Demand for other countries' debt is lower
* Chart on collateral squeeze since QE: reut.rs/2hymSHD
By Francesco Canepa
FRANKFURT, Dec 15 (Reuters) - Banks rushed to borrow German government bonds from the Bundesbank on Thursday, market sources told Reuters, as euro zone central banks launched a new lending scheme aimed at supporting a funding market that underpins the financial system.
The German central bank and six others in the euro zone, including the ECB, began accepting cash as collateral for lending out a small portion of the 1.2 trillion euros ($1.25 trillion) worth of government bonds that they have bought to stimulate the economy under the bloc's quantitative easing programme.
The new scheme is designed to supply the market with quality bonds to in turn be used as collateral for borrowing via repurchase agreements, a key means for investment funds to finance trading and for the European Central Bank to transmit its own policy stimulus.
Aggressive ECB purchases under QE have deprived funds of the most coveted collateral for repo -- high-rated and liquid debt such as that issued by Germany -- risking a freeze in that market.
That led the ECB to announce the new cash-for-bonds scheme last week.
Market sources told Reuters on Thursday that take-up for German bonds was strong and was making commercial banks more prepared to lend them out.
"It's more relaxed than it was five or six weeks ago," a large market participant told Reuters. "More market participants have entered the market and stand ready to lend out Bunds."
Under the programme, the ECB and the national banks of Germany, Spain, France, the Netherlands, Belgium and Ireland are making a total 50 billion euros ($52.13 billion) worth of government bonds available for borrowing against cash, while still accepting government bonds as collateral for the rest.
The prospect of new supply from the central banks had already lowered the borrowing cost for 10-year Bunds, the source said.
The Bundesbank declined to comment while a spokeswoman for the ECB only said the scheme "was launched successfully".
Demand for the other, less liquid sovereign bonds on offer had been less strong, the sources said.
A spokesman for the National Bank of Belgium said it "did not see a strong interest, as the Belgian repo market is functioning well".
Yet some analysts think 50 billion euros will prove too little to alleviate the scarcity in Germany.
"We forecast that the facility would need to be increased beyond its current size by around June 2017 to prevent further collateral shortage in German bonds," Peter Chatwell, an analyst at Mizuho said in a note to clients.
($1 = 0.9592 euros)
Reporting By Francesco Canepa, editing by John Stonestreet