nikola, wish i had a crystal ball to help you with this. the one question that i have is your brother aware of her abberant behavior? i am concerned for the children too. if your brother would be agreeable i wonder if child counselling would help them? would your brother be willing also to do some family therapy with the kids as well?
as for your sister in law if she does have NPD she is toxic to everyone in your family. sounds like everyone is aware of this so that should lessen her impact. i can't see how an intervention would help cause she doesn't see herself as having a problem. if her dx of NPD is correct it would be most difficult to aide her in seeing the problem. idk.
others may have more helpful suggestions. i have a son with BPD so understand the dynamics but am unable to help him. i had to sadly pull away cause he has outrageous rage among other things. it is most upsetting if i have much contact with him. i think the same situation would happen if he had NPD.
Symptoms of Narcissistic Personality Disorder from psych central resource.