I think this is, by far, the biggest change from Morrowind to Oblivion -- in Morrowind there are essentially no personalities, and no memorable characters (other than maybe Vivec, and he doesn't do much, and a few others associated with quests).

In Oblivion there's a few huge changes:
- the AI gives chararacters effectively "personalities", derived from their inclinations. It's just kind of cool to meet, for instance, a ranger in the wood, and see him hanging out at home, practising (and getting better) at marksmanship, making dinner, attacking creatures that come nearby, going to visit a neighbour - my column in the next PCG is largely on this topic;

- even aside from the dynamic AI behaviour, there's a lot of stuff semi-scripted in -- for instance, NPCs will run into each other and have very lengthy, meaningful conversations -- it's not just background noise stuff like they did (to decent effect) in the Gothic series -- for instance, in the assassin's guild, you could overhear one NPC telling another about his last job and the things that went wrong. I encountered a lot of those, and the best thing about them was, I didn't hear a lot (any?) redundancy -- I think there's essentially a pool of conversations for major characters that can pop up, as well as conversations that specifically relate to events that have occurred in the game, which seems really cool. There seems to be a LOT of this stuff.

- all NPCs have full speech, so you don't have to read the text - I still tend to skip through dialogue as fast as I can read it, but it's obviously cool for ancillary conversations not involving your character.

- there's things like Newspapers which are also updated based upon events in the game (for instance "emperor assassinated", is a headline at the beginning of the game), and you see NPCs reading the paper and blabbing about stuff in it, etc.