The decision was taken at the BRICS Summit in Durban which also launched a Business Council to encourage investment and trade in member countries and to expand business cooperation.
Leaders of the inter-continental grouping including Prime Minister Manmohan Singh, met here this morning for an extended session and accepted the report of their finance ministers saying "we are satisfied that the establishment of a new development bank is feasible and viable."
"We considered that developing countries face challenges of infrastructure development due to insufficient long-term financing and foreign direct investment, especially investment in capital stock," he said.
"This constrains global aggregate demand. BRICS cooperation towards more productive use of global financial resources can make a positive contribution to addressing this problem," the leaders said in a statement after the two-hour summit.
However, the leaders did not decide on the capital for the proposed bank leaving it to the finance ministers to negotiate this and other issues before September.
The development bank, mooted by India at the last year's summit in Delhi, was originally proposed to be started with a capital of $50 billion with $10 billion from each of the members.
Incidentally, differences appear unresolved with reservations from South Africa and Brazil over the contribution.
Hailing the development bank initiative along with the other leaders, Mr Singh said it gave him great satisifaction to note that one of the ideas that they discussed first in New Delhi - that of instituting a mechanism to recycle surplus savings into infrastructure investments in developing countries - has been given a concrete shape during the Durban Summit.
"Our finance ministers will now work to develop the details of the project," he told a joint press conference with the other leaders.
Besides host president Jacob Zuma, new Chinese president Xi Jinping, Russian president Vladimir Putin and Brazilian president Dila Rouseff participated in the summit.
In his address, Mr Zuma said the summit decided to enter formal negotiations to establish a BRICS-led new development bank based on their own considerable infrastructure needs, amounting to $4.5 trillion over the next five years and to cooperate with the other emerging markets and developing countries in future.
Briefing reporters after the summit, Finance Minister P Chidambaram said India gave two big ideas -- BRICS Development Bank and a Contingency Reserve Arrangement (CRA) at the Delhi summit last year and "they have now become a reality".
"Both the ideas have been approved by the leaders. Whatever the individual views of the finance ministers, the leaders have wholeheartedly welcomed the establishment of the Bank and the CRA," he said noting the Brazilian President's remarks that the capital of the Bank must be commensurate with the challenges and goals of the Bank.
He said Mr Putin fully supported establishment of the Bank while China had always been enthusiastic in supporting the bank.
Mr Chidambaram said India wants a nearly complete document before leaders meet for the summit in Brazil in March next year.
He said the initial authorised capital of the Bank was $50 billion but it was decided not to take a call at the first stage. It was agreed that the countries would work it out later. It depends on the members' capacity to contribute. A lot of work has to be done in the next 12 months on capital, membership, governance and domicile issues. There is an internal programme which divides the task and he hoped officials would be able to complete these.
On the contingency reserve arrangement, the minister said India is comfortable with a fund of anything between $50 billion and $100 billion.
There was agreement that China, which has a huge foreign exchange reserve, will contribute 41 billion while it will be 18 per cent for others except South Africa which will contribute $5 billion.
He said the likelihood of any of the five countries to resort to the CRA for overcoming liquidity is not there. It was only a precautionary measure that can lend stability to the system.
Mr Chidambaram said India was happy with the setting up of the BRICS business council and the BRICS think tank.
He noted Putin's remarks that the five BRICS countries account for 27 per cent of the GDP and total of $5 trillion which make it the important and significant group which can influence discussions in the G 20, IMF and other multilateral institutions.
"If these five countries work together more closely in the days to come, they will become a power in the international matters," he said.
India, like the other BRICS nations, has been campaigning for reforms of international financial and political institutions to reflect the current day realities. It wants reforms of the Bretton Woods institutions like the World Bank and the IMF and the UN Security Council.
In the development bank, the finance ministers would still have to decide first on its capital, membership and the location besides governance issues.
Opinion is divided on whether to confine membership to just the BRICS nations or to allow others like developed economies. Also India feels there is need for caution about excessive contribution by any one nation to the capital which could lead to that country having a dominant and influential role.
In this context, the Chinese readiness to pick up stakes on behalf of those not in a position to contribute is viewed with reservations by India.