Touch ID won't work to wake MacBook Air M1 from sleep, but will unlock screen when prompted

So I was having the same problem with my M1 Pro, on charge I can wake up the Mac with just Touch ID at any time, as long as “prevent computer form sleeping” setting is turned on.

On battery after the display turns off after about 1 minute the Touch ID become unresponsive until I physically press a key to wake it up, then I can unlock it via Touch ID

So after 2 days chatting with Apple support, resetting SMC, NVRAM, Updating and Reinstalling the OS, I just got off the line with a senior Apple tech whose been working with Touch ID from first gen and he says that’s how it’s supposed to work, you need to physically press a key or track pad to wake it and then you can use Touch ID.

I think I might have managed to reproduce your problem, although it is still confusing. It looks like it might depend on the Sleep and/or Screen Lock status, and maybe how long it has been in play. I made all my tests from the Apple menu, selecting either Sleep or Screen Lock so remember it might show different behaviour if the black screen is invoked by inactivity timeouts. Hopefully this will give you some clues to test more at your side and identify the differences between you and sibling.

Start by comparing your settings in Preferences/Security & Privacy. My choice here is (enabled) Require Password (5 minutes) after sleep or screen saver. Screen saver is set to activate at 10 minutes. All tests while running on battery.

Note: Selecting Lock Screen blacks out the screen about 4 seconds after the lock is activated.

If I select Sleep in the menu, then test Touch ID within about 10-15 seconds it will wake the MacBook immediately

If I select Sleep in the menu, then test Touch ID in >30 seconds <5 minutes it needs a positive key stroke or trackpad click action.

If I select Lock Screen in the menu, then test Touch ID in <1 minute it will wake the MacBook immediately and unlock with either TouchID or Apple Watch (seems to be random which is used)

If I select Lock Screen in the menu, then test Touch ID in >2<10 minutes it needs a positive key stroke or trackpad click action to wake the MacBook.

Check again and compare, Preferences/Security & Privacy, Require Password setting. Maybe turn it off and exit, then go back and turn it on again so it is forced to rewrite the setting. It has to be something simple like this in the settings... when you finally look in the right place.

I don't think this is a hardware problem, you should not doubt the MacBook and we don't even know which one is behaving "correctly". There is a basic guide for troubleshooting - if the problem is random in occurrence it is probably hardware. If it can be reproduced by a defined set of user actions it is probably software.

I think uninstalling the the OS was probably not necessary. All MacBooks will be loaded from the same master image before delivery and you didn't really have time to break it in 2 days after it arrived. Hopefully you can reload successfully, just make sure you end up with MacOS v11.1 (today's latest) when you finish.

Based on your latest comments I am pretty sure this problem will turn out to be something different in settings between you and your sister. I assume in this you both have completely identical devices, both late 2020 MB-Air, M1 Apple Silicon, same memory, same MacOS version, etc. I don't think any difference in downloaded user apps is likely to be significant unless there is something with the ability to prevent Sleep after user-inactivity timeout.

Your question about the different routes into a Sleep condition - We Don't Know, only the developers know for sure. They start at a different point, either menu or an inactivity timeout and if I was writing it they would both call the same Sleep() function at the end, but there would be different routes through the codes to arrive at a common point. However, I didn't write it so we don't have a clue.