Sir William the Brave said:
Remove Swadia,Rhodok,Vaegir and Nord and form it into a Human Empire.
I support this, maybe making 2 or 3 human factions, thus allowing for the current Phantasy factions having more land.
The best thing IMO to do with combinations of Human factions would be to have some bad humans and some good Humans. For example Rhun, and Harad were men but still fought alongside Mordor. While Eriador, Rohan, and Gondor fought for the "Men of the West".
Maybe having the Sarranids be similar to Harad and having the Khergits similar to Rhun.
Having those factions be "bad" though would introduce another problem, factions like the Dwarves would be getting gangbanged by the evil factions. Possibly moving them to the mountains would be more appropriate to Dwarves.
Move the Dwarves to where the Wizards are, have the Wizards be where the Dwarves are(since the current placement of the Dwarves seems really excluded and in every fantasy story the Wizards like their personal space)
Increase the Size of all the non-native factions and have the "Good" Human faction based around Praven, while the "Bad" Human faction be based around the Sarranid capital. The good would be Half of Rhodoks, All of Swadia and All of Nordic lands and half of Vaegir, while the bad would have all of Sarranid, all of Khergits and half of Vaegir.
Breaking up the native factions should allow for the current Phantasy factions to have 1-2 more castles allowing for more presence.
Having a "bad" side v. "good" side and locking their alliances with some factions would allow for a more desperate feeling. Currently when war is on, I feel as if nothing is happening. In LOTR the struggle to survive and destroy evil is what really made Tolkien's stories intense but also interesting.
New armor and weapons and more mechanics would be needed. Better but also more fragile economy, the equalization of armies as of now the Phantasy v. Native armies are silly, but yes, needed to stay balanced, just need to be tinkered. Having armors that signify good, and/or bad would be very nice, having evil humans wearing the dark red, black or gray clothing while the good would wear white, bright, natural colors.
Essentially with the "good" v. "bad" scheme would allow for a more prevalent power struggle. You'd feel like you need to join in if you want your realm to live.
EDIT: Also, lesser orcs or Goblins I think are a must.