Being able to loot items characters are wearing will kill guilds like Azrael. I think a little tweaking needs to be done and there are really just two general directions to go with this, providing more armor you can wear that is no drop or limiting what can be looted.
With all item loot systems I would like to see bags have no effect on whether or not an item could be looted.
1) make more items no drop, sol temple quests, kunark armor pieces, etc.
2) limit what you can loot by slots
a) can't loot what people are wearing
b) character given 4-6 worn slots that they can choose as non lootable slots - this allows players to wear a couple of real valuable gear that they can't
c) a compromise on not being able to bag items - have characters start with a bag after character creation that can hold items and make them not lootable. You could even make the bag small with 4 slots.
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