You would need a properly layered engine. The full lore is baked into the global engine. Each NPC gets their own biasing in the engine. A subset of knowledge they have, as well as things they explicitly do or don’t know.

Generating the underlying knowledge set, in a way that is easy to work with will be the challenge. It’s ok for AI to fill in the gaps, but the story designers will need an easy way to get them to behave properly.

There will also be a lot of unintended consequences. A good team would be able to do amazing things with this. A bad team would produce a complete mess.