Yes, Fable was indeed on the right track, but not with one foot off in the brush.
I enjoy both choice 1 and choice 2, though I would prefer a more moderated version of choice 1, in which it is possible to actually lose (*Diablo and Fable players gasp in horror*).
However, and perhaps in saying this I am a strange person, but I somewhat prefer the battle systems of console RPGs such Suikoden 3 and the Star Ocean series- a 3d or layered battlefield where the enemies and characters battle each other, moving freely across the area.with RPG-stat trappings. This allows both careful planning ("We'll send one character so, and another so, and bam, we have a pincer attack.") and fast-paced action (in fact, in the underrated Star Ocean 3, the battle system is very similar to a fighting game.)