ct.category theory - What are natural transformations in 1-categories?

Here is a counterexample for your next-to-last question. Let S be a set with more than one element and consider the two full subcategories of Cat on, respectively, the single category which is the discrete category on S, and the single category which is the codiscrete category on S. In each case, when viewing Cat as a 1-category, the resulting full subcategory has a single object with endomorphisms Hom(S, S). However, if we view Cat as a 2-category, the former subcategory has no nontrivial natural transformations and thus really is BHom(S, S), while the latter has a unique natural transformation between any two functors and thus is actually • up to 2-equivalence.

Cat-the-1-category and Cat-the-2-category are very different constructs which unfortunately usually go by the same name. Even though they have "the same" objects, I suggest thinking of their objects as being different kinds of things. An object of Cat-the-1-category has more information than an object of Cat-the-2-category; we may talk about the cardinality of its set of objects, not just the cardinality of its set of isomorphism classes of objects. (This shouldn't seem too strange, since an object of Cat-the-0-category is a "specific" category, of which we may talk about the actual set of objects.) Put differently, an object of Cat-the-1-category is a "monoid with many objects", while an object of Cat-the-2-category is what we more often think of when thinking about categories (especially large ones).

In your example, you expressed Ab as a full subcategory of Cat-the-1-category. The full subcategory of Cat-the-2-category on the same objects is not Ab, since it has nontrivial natural automorphisms, as others have pointed out. It only becomes Ab after truncation—replacing each Hom-category by its set of isomorphism classes of objects. For Grp, the situation is worse, since distinct group homomorphisms may be naturally isomorphic as functors. The usual way to repair this is to work with "pointed categories", as described at this nlab page. But of course this is a kind of extra structure on a category, and if I'm allowed to introduce arbitrary extra structure then the question is too easy. Anyways, I'm not sure that one should expect various concrete categories to naturally be full subcategories of either Cat-the-1-category or Cat-the-2-category.