Immigrationboards.com

I am a British national and have been back in the UK with my wife and kids for 2 years after having lived abroad for around 16 years.

Am I, as a British national, not considered settled after only 2 years? If not, does that invalidate my wife's application for ILR?

Thanks in advance for any help.

My wife speaks fluent English - does she need an ESOL qualification or is it okay if she just does the Knowledge of Life in the UK test?

Thanks.

As a British Citizen you were considered 'settled' as soon as you arrived back in the UK. If your wife is fluent in English (i.e grade 3 or above) she will only need to pass the KOL test before she applies for ILR. Bear in mind that the test material is due to change considerably sometime soon. Possibly as early as September.
Once your wife has ILR and assuming she meets all the other conditions, she will qualify for BC after she's spent 3 years in total here.

So she does not need to pass an exam to prove her level of English as long as she has the KOL as that is in English and proves her English is good enough I suppose.

That's right. The KOL test by the way isn't actually a test of her level of English...it's to check her understanding of life in the UK.
The new rules, which don't affect her, from Oct 2013 require the applicant to take a B1 English test for ILR as well as KOL.

That's great.