Every story needs characters - and, as we said in part one, every game is a story. Players need characters they can relate to, villains they can loathe, legendary heroes they will look up to, lovely maidens or tall, dark and handsome strangers to chase after, and all sorts of people with their own little stories to make the players a little bit sad, happy, warm-and-fuzzy, or scared to death, according to the mood the story needs. The narrative function of characters in the game is luring the players into the game's world and story, and giving them a motivation to act (nobody wants to save memory location #00F53A from the dreaded ADD AX, they want to save Princess Daphne from the dragon).
Besides their narrative function, though, characters in game also have a role which is more tied to the gameplay aspect: they provide exposition to lure the player into the story and help them solve riddles and puzzles, they serve as gameplay agents (e.g. by providing the player with items or powers), as aides and allies in the actual playing (e.g. a sidekick fighting along the player's hero) and of course as gameplay antagonists (e.g. monsters and bosses).
Like the narrative nature of the game itself, these two aspects of characters must also be balanced: too strong a characterization can make for a very well-written character but can bog the gameplay down, while a game full of cardboard cutouts and "Generic Mercenary Soldier #1 through 256" makes the players regret they didn't stick with Space Invaders.
Archetypes and stereotypes
An archetypal story structure comes, of course, with archetypal character figures. They range from the Guardian of the Threshold (the obstacle to overcome in order to begin the adventure itself: a mentor putting the player to the test, a loved one that begs them not to go, mom who has grounded you for life, or the boss of the tutorial section) to the Trickster (the amoral, chaos-driven jester: from the mythical heights of Loki and Anansi to Bugs Bunny and Bart Simpson - and to certain incarnations of the Joker), from the Shape-shifter (the two-faced friend whom you can't trust until the very end - Lando Calrissian, or pretty much the entire cast of Alias) to the Nemesis (pure evil incarnate, like BOB or Hannibal Lecter; or a tragic figure, like Darth Vader). And this small selection doesn't even begin to cover the whole range of them. If you're brave enough, take a look at TvTropes and you'll find a wide variety of examples.
The problem with archetypes is that they're easily spotted, somewhat predictable ("I have altered our deal..." - gee whiz, Darth, nobody saw that coming, really !) and tend to be less than interesting in their pure form. That is why they are usually more fleshed-out and added at least a few original traits and facets, or at least some quirks of character and aspect that help characterize them further. This can involve a lot of work, therefore a full-on characterization is often limited to major characters.
Stars and bit players
The only obviously major character of the story is our hero, the player character or PC. His characterization depends mostly on the nature of the game: some start with a well-defined character that the player is supposed to relate to (this often happens in licensed games, as we will see later, and in strongly story-oriented titles like LucasArts adventures), others with a generic enough template that leaves enough leeway for the player to build his or her own character (think action-RPGs, for instance), others still with a wider range of freedom except maybe for one defining element (sandbox games and MMORPGs). The PC's characterization will have much more to do with the game's target audience and demographics than with the storytelling, since much of the narration and immersion is provided by the other characters.
Other major characters (constant companions, recurring aides or antagonists, important figures in the game world) will often be fully fleshed-out, with a detailed backstory and character study only the surface of which will be visible in the game (but will certainly be featured in Easter eggs, dev diaries, director's cuts, and the like). They will often have some story focus and a character arc, a growth or evolution in their characterization that maintains their basic outlook while changing a significant aspect: thinking again of Star Wars, Han Solo goes from a no-nonsense mercenary only in it for the money (and who shot first!) to a hero of la résistance willing to give his life for his friends, his love or the greater good - while remaining a wisecracking, rough-cut scoundrel.
Minor characters and bit players are more functional than anything else. They need a basic motivation, a role in the game and a few identifying aspects (in their appearance and/or dialogue), and they usually either serve a specific purpose: a chatty employee of Evil Inc. inadvertently giving some key information, an Imperial Stormtrooper inefficiently shooting at the player, an ensign in a red shirt who gets killed and shows how real the danger is. Alternatively, they serve to characterize the game's world itself, adding each their bit to the main picture.
Of canon and nitpicking fans
All of this, of course goes out of the window when a licensed property is involved. If the PC is Superman, he'll be the Superman, and Lex Luthor will be the Lex Luthor. If a game is set in Springfield, Homer Simpson will be a lazy slob who says "D'oh!" a lot and Cletus will be a slack-jawed yokel. And, most importantly, translations must strictly follow the respective localization of that license, or the fans will be immediately disgusted and the backlash will be brutal ("Worst - license - ever!").
This part concludes our general chat on the nature of games as a narrative experience. The next parts will delve more deeply in the peculiar aspects of storytelling in games as opposed to other media.