Heh, normally I don't get involved in these arguments, because of my somewhat limited expertise. However, I have done some research on the katana before, so I'd like to insert a bit of a refutation to your comment about it, bewing. I won't deny that the art of katana making evolved over time, and there are indeed records that, at points in that evolution, it had a tendency to break when used against certain armor types. However, to say that a katana was more susceptible to breaking because of being a harder blade is somewhat inaccurate.
In the forging process, the hardness of the steel was a product of how fast the blade was cooled. They only wanted the leading edge of the weapon to be particularly hard, so that it would hold its edge, so what they'd do is cover everything but that leading edge in a clay mixture before shoving the whole thing into the water. Result: The edge was, as you say, hard. But the rest of the sword was softer, and thus less brittle, more durable.
As for the subject at hand, I'd be strongly opposed to a sword breaking all at once. Over time, it might take some damage, but there should be ways of repairing it. If it's just a matter of a blade getting dull, I don't even know if that warrants a blacksmith. Just buy a whet stone, and sharpen it yourself. If the damage os more serious, such as chipping, I'm not qualified to say of there'd be anything a blacksmith could do to repair it, but for the purposes of this game, I definitely think it should be possible. Same with armor. I think it'd be cool if a blacksmith could upgrade any piece of equipment to the highest quality in the game (Reinforced, watered steel, and so on.). It would just get progressively more expensive.
As to the suggestion that you'd get knocked out in battle, without the battle ending then and there? Hell no. What possible fun would a player derive from sitting there and watching as his character is hacked to pieces without any means of fighting back?