This study aimed at investigating the challenges and prospects of Islamic banks operating in the Palestinian territories. The study starts by a historical background of Islamic banks. Four Islamic banks are now operating with 12 branches with total assets of about 261 million dollars as at the end of March 2001. The study shows the market share of Islamic banks of the banking market, Investments classification according to economic sectors. And challenges which face Islamic banks. The study ends with recommendations. These recommendations help these banks to prosper and grow.