All the countries involved except Paraguay are led by left wing leaders and the bank is an initiative of Hugo Chavez, the Venezuelan president, who envisions lending under rules designed by member countries rather than by Washington or Europe.
"We're making a decisive step in building the integration dream of the peoples of South America," Luiz Inacio Lula da Silva, the Brazilian president, at the signing ceremony in Argentina's national palace, known as the Pink House.
The bank will fund development projects and each member country will have an equal say in how it is run.
The members' economy ministers will decide funding and operation details over the next two months.
Finance ministers of Argentina, Bolivia, Brazil, Ecuador, Paraguay, Uruguay and Venezuela will sit on the bank's board.
Officials say it will dispense loans for projects from road-building to anti-poverty programmes and regional integration plans.
Venezuelan officials say the bank's loans will be issued at interest rates similar to those of other international lenders.
Chavez and Nestor Kirchner, the president of Argentina, pushed the initiative to create the regional bank in 2006, hoping it will help wean the region off what are widely seen as the negative influences of the IMF and World Bank.
Chavez said the bank was part of a broader "war" with the more advanced nations of the north.
"The bank is a political fact and is part of an economic war that is also social and ideological," Chavez said.
"We don't have money? We do, but it's deposited in banks of the north, in US treasury bonds ... in euros, in yens. The time has arrived to begin to bring these resources to the region," he said.
Chavez earlier blasted the IMF, describing it as "a curse" on the region, and slammed its "shock politics that have spread hunger, misery, poverty and violence to our peoples."
Brazil's Lula said the regional bank "will finance projects in key economic sectors such as infrastructure, science and technology, and bring more balance to the region".
Rafael Correa, the president of Ecuador, said that the Bank of the South will help Latin America break out of its financial chains.
"Its a huge step on the road to Latin American integration. We have a common past, now its time we aim for a common future," Correa told reporters.
Evo Morales, the president of Bolivia, said the bank would help South America develop its own currency and resist the pressures of international lending institutions that demanded the privatization of state-owned companies in return for their loans.
"With these (new) financial instruments, we can generate equality among our nations. Hope is reborn in our countries with the Bank of the South," he said.
The bank will start operations in 2008. It will be based in Caracas and will have regional offices in Buenos Aires and La Paz.