I don't think it's the leveling system that's the problem. The Elder Scrolls games (from Daggerfall on) do leveling the reverse of traditional RPGs. In traditional RPGs, you're awarded experience points for killing enemies, finishing quests, etc., and when you accumulate enough XP, you gain a level. At that point, you are allowed to increase one or more skills by a certain number of points. Even Fallout 3, a Bethesda game, does something like this.
In TES games, yours skills advance from using them. When you advance your main skills a sufficient number of times, you level up. I actually like this concept, because it means that my character is learning by doing, as in real life.
The problem in Oblivion is that the rest of the world levels up with you, at a rate that makes it easy for the player to fall behind. This problem doesn't usually appear until somwhere in the teens, when harder creatures with resistances and regeneration start showing up. If the character's primary combat and defense skills have not been developed efficiently by that time, the game starts getting progressively harder.