Common scene: Thudgrind the Barbarian takes 500 points of damage, his pots and pans absorbing 60%. It doesn't show.
A suit jacket looks good. It should be tailored, clean and pressed. Most of the things we do require a shirt, suit, or lab coat that makes us dapper and presentable. Keeping these
vestments clean is an untapped source of dramatic tension.
White Shirt Online is a MMORPG developed with the standards you expect: items, levels, skills, and quests. All the armor, however, would include suits of real clothing. Why not wear metal? You get extra experience points for looking good even if you do take massive damage without the washbasin on your head.
Kids would love to role play in decent clothes. The girls would like to dress up as they do IN EXISTING GAMES, I KNOW, SO DON'T TELL ME. I'm saying they could splash paint on one another for style or sabotage. They could tear the clothing either to embarrass someone or to reveal themselves deliberately. I can't believe how bad that sounds when I write it out, sorry.
The boys would enjoy finally looking sleek and professional instead of covered in metal. They might take pride in wearing a clean, in-game expensive white suit. Or they might choose to never change their clothing in order to build their reputation as antisocial and rugged.
Vulnerable clothing would add a new social dimension to the game. You could demonstrate your superiority by wearing a dinner jacket that restricted your movement speed and did not protect at all against swords. You could offend a member of another clan by squirting mustard on him. You could determine, like a detective, where a person had been depending on the mud on their shoes or a telltale bloodstain.
And one other thing. The female characters in these games usually wear revealing clothing that I find too deliberate. If instead they wore conservative clothing that was ripped during a massive battle or by walking through some forest brambles, that would be vastly different. Do you see why, or am I making this up? Seeing a game character accidentally reveal herself is about thirty times more pleasant to me, morally, than a debauched garment that serves an ugly purpose from the moment it is first worn.
I don't want to hear you say it would get annoying. Flight simulators get annoying to people who hate flying. Come on, it would be infinitely trivial to make an "opt out" so that you could play the game without caring about your white shirt.
I also don't want to hear that it can't be done or that it would take too much server power to transmit complex data about the clothing. The cloth ripples could be computed locally given some vector data about the rips. The stain effects could be transmitted gradually over time and stored as a new, adjustable bitmap of the same sort used to color the wire meshes currently. A little extra resolution would not excessively strain modern networks, I think.