it's a mixture of both religion and culture. your family and your in laws are judging you and treating you based upon their own interpretation of islam. your in laws are also culturally very insular and so not open to understanding or tolerating a different way of doing things - with clothing for example.
my family were strict muslim when i was growing up but not extreme conservatives, we didn't wear hijabs but i was expected to adhere to their way of dressing in the family home. so i can understand the insanity around their attitude to you wearing 'western' clothes - i used to wear jeans and long sleeved shirts to college (the only time i wore western clothes) but all the small minded/brainwashed kids would still accuse me of dressing like and wanting to be a 'white person', i was a 'slut' etc. i knew when i was 10 years old that i was not a muslim and that lifestyle was not for me, as i got older and more vocal about that i would be told that i was going to 'burn in hell' because i refused to be muslim or believe in god....i actually do believe in god just not in religion but there is no difference between the two for those who are brainwashed/extreme in their views.
your husband is being a coward, sticking his head in the sand will not make the problem that is his family's attitude and behaviour disappear. you can use this to your advantage and lay down the rules for what is unacceptable language and behaviour in your home when it comes to his family visiting. when they don't respect that you ban them from your home. you don't have to have ANYTHING to do with them.
I want them to be raised as good people and I would vaguely like them to have an Islamic grounding in case when they are older they get strength from faith and choose to practice
how about teaching them about all the different faiths and religions out there? they will see what all these ways of life have in common and what they don't, they will learn that you don't need religion/belief in god to have morals and standards and values, and if/when the time comes they will be educated enough to make a fully informed choice about pursuing a particular path.
the problem i see with giving them a 'grounding' in islam is that as they get older and naturally start questioning your beliefs/rebelling or they have an existential crises, the only 'real' thing they know to fall back on will be islam and given the in-laws pernicious influence you may find your own children ending up exactly like them. so you're not really giving them a choice.
your self esteem issues will only get better once you start standing up for yourself and making those hard decisions about how much (if any) contact you have with your in laws and follow through with the consequences if they don't respect your wishes.