I agree that they should be able to level up once conquered. I assume the premise is that they don't expand on their own due to a lack of ambition. There's no reason why the city should be magically incapable of growing no matter who controls it.
I agree. Though honestly I'd like to see the minor factions be allow to improve their cities, but just not found more than 1. It's really no challenge to smoosh a tiny tech-less city if you want to, so I kind of wonder why they're there at all. Unless it's just to mix things up a bit.
I think my preference would be to see the minor factions automatically gain any techs that have been researched by, say, over 50% of the main factions. They can then use that tech to improve the one city they have. Until I conquer it. 
It just seems kinda silly that in a world where there are so few channelers, a couple decide to found one-village kingdoms and wait to get rolled over by their neighbors.