I find that the system for clothing npc's in most game is rather bland. All NPC's wear the same clothes all the time (even when sleeping). What propose is having a system where the npcs will wear clothes fitting within particular paramiters at various points in their daily cycle. With this system they will be wearing appropriate clothing for what they are doing.
For peramiters I like to see at least two categories: function and culture. At the various points in the npc's cycle the programer can designate whether they should be wearing work clothes, formal clothes, travel cothes, comfortable clothes. The game would then cross reference with the character's race and develop a list of possible outfits the character might be wearing and then randomly selects from this list. As a result the characters would always appear properly dressed and there would be a constant diversity, keeping the towns and villages looking fresh. I might be interested in seeing a price category as well, so that a character's status might be readily appearant from their clothes, particularly in social settings where characters are trying to impress.

As an added bonus, this system permit used created clothing to spread throughout the game world as soon as they were added to the game, without the need for a mod to give the game a face lift.

One thing that just irked me in Oblivion was seeing people sleeping in their normal clothes... Even the Counts and Countesses would be wearing their royal clothes to bed! I felt like they were just napping to be honest. I like your solution to this problem, but some of it seems too much. I think they really only need 2 sets of clothes; Work and sleep clothes.

i think npc's should be butt naked.
just kidding.

i think oblivion handled it reasonably well.

on sleeping:
i wish your character and NPCs could actually sleep under the blankets. im not sure how hard this would be to program/animate into the game but it would feel more comfortable

I like that, there should also be schdules that allow them to use the clothes, not just daily routines, but say visiting relatives once or twice a month, wearing nice clothes to church, etc.

Sleep in undies!

I don't think barbarians had a wardrobe.

Let's see, today I am going to wear the skin pelt... but for supper, how about the wolf?

well the sims can do it im sure bethesda could xD

i agree with the OP people should dress properly for the occasion

Let's not make the AI any more complex for the NPC's. God knows they'll be a bug and the King of Winterhold is walking around in his undies because his AI package on putting clothes back on didn't activate.