The university would be the first of its kind in the troubled Muslim-majority region, an official statement said on Tuesday.
"The university will be set up by Kashmir's Muslim wakf (endowment) board," the statement said, referring to the government-backed board that manages all shrines and Islamic sites in Kashmir.
"The university will be a self-financing institution with no grant-in-aid provided by the government," the statement said.
Kashmir has four existing universities, one of them set up by a trust managing a revered Hindu shrine in the region's Jammu area.
The university is being established "to promote higher learning in Islamic, scientific and technical education," state Chief Minister Mufti Mohammed Sayeed said after the provincial cabinet gave its approval for the venture.
"Significantly, the university would be open to students of all communities without any discrimination of religion, caste or creed"
Aside from regular studies, the university is expected to offer correspondence courses and research facilities.
"Significantly, the university would be open to students of all communities without any discrimination of religion, caste or creed," the statement said.
Education has been badly hit by 16-years of fighting against Indian rule in the region, with many schools going up in flames during clashes between soldiers and separatist rebels.
Some are under occupation by the large numbers of Indian soldiers pumped into the state to fight the insurgency that has left tens of thousands dead.