I work in Y2. We don't do a nativity but we do an end of year show in July. We do auditions, in front of the Y2 teaching staff and in front of their peers - so 90 children in room.
They decide which parts to go for and hghlight if they would be interested in:
a large acting part with several lines
a smaller acting & talking part
a non talking acting part
part of the choir/ensemble
They then go and sit in those groups on the afternoon. They are given a short talking part (if going for a talking part) to learn, along with some suggestions for expression and how to act that part - so about 30-60 sec worth of talk/act. They have about 15-20 minutes to practise, with support from teaching staff.
Those wanting a non talking part or a part in choir/ensemble usually watch and form the audience = we don't need them to audition at that stage, but for those who do want to audition we want to see how they come when put on the spot and in front of others - and, especially for a main part, how they can fill the room with their voices as we perform in a larger room than our hall.
After that practise time the all sit and watch and we call them out in small groups. We then have them line up and one end of hall facing teaching staff, and then are called forward 1 by 1 to "perform" their practised bit. Teaching staff make notes during this time. All get a huge clap from their peers.
It is a bit of pressure but in a very controlled way. We accept some neres and its all done very gently, even though it sounds a lot more presured - it really isn't, it works well and is generally a good fun atmosphere in the hall.
The teaching staff then go away and argue it out between themselves. We try to let them know by the next day.
Everyone who wants a talking part will get one - though obviously not everyone will get a big part, even if they wanted one. If necessary we will make up extra speaking bits even if just one short line or talking with a partner or two. This is explained beforehand, especially when noting down specific characters they are interested in. We also explain that we don't want any of the whole insisting on only one part or nothing at all - they will be offered a part and if they refuse it that may mean they don't have a talking part at all, or a much smaller one - we wont pull people out of their given role just because a child complains. We definitely won't if it si a parent complaining.
If we get someone very good who only put down for a small part we may chat to them to make sure they wouldn't rather have a big part too.