Does his sister have to be a bridesmaid?

Absolutely not. Not if you don't want her to be! It's YOUR bridesmaids, your nearest and dearest. She could maybe have another role though, like doing a reading for the ceremony or giving a toast or something like that

I also am in the minority; it would be nice if you included her as BM. you said your FH was like a father figure to her and his brother -- unless you have a real problem with her, you should include her. i'm assuming his brother will be a GM, too, though. and leave it up to your FSIL to decide about graciously declining if she does not want to take on the financial burden.

i know i would be really hurt if my brother's FW did not offer for me to be a BM to include me.

Nope. She doesn't have to be. I would honor her with a corsage and leave it there.

Unless you FH wants her go be part of the wedding party, that's a different story.

Sounds like a pretty clear majority here, and I agree. YOU pick who your bridesmaids are. Sure, many people include siblings-in-law, but it's by no means a requirement, nor an expectation. If you aren't that close, you MIL should understand. Even if the MIL is willing to pay for the sister's bridesmaid dress and such, you still have the final say. However, it might be best if your FH has that conversation with his mother so it's coming from him -- and you don't come off looking like "the bad guy" in the situation.

Bridesmaids aren't just for show, they're traditionally expected to assist you with certain aspects of the wedding. By the sounds of it (from one of your earlier responses) it sounds like this girl isn't mature enough to handle those duties, nor to be included in any of the adult locations/situations/conversations that might be part of a bachelorette party... so even if you include her as a bridesmaid, there's only more drama when she's the only one who can't go to the bachelorette (or when you have to force everyone else to "scale it down" just for her).

Perhaps she can be involved in some other way... perhaps as an usher and/or a reader at the ceremony. But it could be discussed with her mother that she'll be expected to wear appropriate clothing and make-up... so you avoid getting stuck buying her an expensive bridesmaid outfit but you still eliminate the "raccoon eyeliner" and skimpy dress problems.

You don't have to, but would it kill you to include her? It's really just a nice gesture, no matter what the circumstances. Your FH is obviously close to her, and your bridal party should represent both of you. What if you had a brother you were close to that he didn't want to include? If it were me and the tables were turned, I for one, would want my brother to be a groomsman.

I do agree that you should ask your FH what he thinks. Marriage is about comprimise sometimes. If it makes HIM happy (not your FMIL, she does not get a say) then make her a bridesmaid. If he doesn't care, then don't...

Edit: Agree with @KarenM!!! Yes, you don't HAVE to make her a bridesmaid, but it would be nice, and it would set you off on a good foot in your "new" life if you did. If you don't make her a bridesmaid it might start some bad vibes between you two, and I'm sure you don't want that.

Where I'm from (or in my circle), the respectful thing to do is for the bride and groom to each choose one person that represents FH or FW's family/friends. For example I chose all my girls but let him suggest one girl from his family to stand with me. He chose his guys and included by brother. Weddings are about the coming together of families. Unless you absolutely hate her, you should include her. It's a way of showing that you are open to building relationships with his family.