1. You'll need a dds converter, I use DXTBmp http://www.softpedia.com/get/Multimedia/Graphic/Graphic-Editors/DXTBmp.shtml
2.You'll also probably need some sort of image manipulator like Gimp or Photoshop
3. In DXTBmp open one of the banner texture files depending on which flag you wish to replace. banner texture files are called "banners_a.dds" and "banners_b.dds" they are located in the textures folder of Napoleonic War. On my computer the filepath is:C:\Program Files\Steam\steamapps\common\mountblade warband\Modules\Napoleonic Wars\Textures
(3.a. It's a good idea to back these files up before you replace them)
4. Once you've opened the banner textures convert them to a 24 bit bmp by saving as. call it banners_a.bmp or whatever you want
5. Open the Bmp with your image manipulator or MSPaint and paste your banner over the one you wish to replace. Then save it.
5.a (New step)
I've created a crumple effect which you can put on top of it if you like: click the image to download
5.b Create a circle with a diameter of 147 pixels (so that it just touches the edges of your banner) this is what it's going to look like in game. Make sure you're happy with that! Erase the circle as it was just for illustration
6. Using DXTBmp open the updated bmp and overwrite the original .dds file
7. Start up Napoleonic Wars and test it out!