I have Vista Home Basic recently installed SP1, System Restore should automatically create restore points daily plus when applying update from windows update. I noticed however I doesn't automatically produce these points daily. Please help.

Try to create one manually and see whether it created one. You can check with command prompt (run as admin) type VSSADMIN LIST SHADOWS

I am not sure where you looked. Go to System and Maintenance > Backup and Restore center. In the left pane click "Create a restore Point or change settings", Wait for a little while as it is collecting the data in the System Properties window and see whether the little box in front of C:\ is checked, if not, check it.

That is strange. When you checked with VSSADMIN, was the shadow that you created the only one it showed?

So I gather that a shadow is written when you force one manually and when something is being downloaded - but not on a daily basis as it should. Did you download anything other than SP1 lately? I ask the Q because it then should have written a shadow then too.
By the way; I have seen the same problem on another PC with Vista Basic - strange!

Check once how big your shadowstorage is. Same routine as above with Command Prompt. The command is: VSSADMIN LIST SHADOWSTORAGE. There are 3 numbers: Used, Allocated and Maximum. It's the Maximum number that is the one we are looking for.

That is very little space and probably full. Each shadow takes about 1GB. When full, it reuses the space. But you really only have space for 2 shadows (it also needs some space for 'header' info). How big is your C: partition. We will resize it accordingly. Someone must have reduced it to 3GB's because that would be only normal if C: is 20GB's - which is probably not the case.