Carole Davison was surprised when she got a text offering her £500. "I've got a bad credit record," she says. "I was put into debt by the [Inland] Revenue: It's 'approval for a £500 loan' and I never applied for anything".

The irony of Davison receiving such an offer is compounded by the fact that she works for a church project counselling people with debt problems on Tyneside. Thousands of stories of the greed and cruelty of loan sharks pass through her small office in South Shields each year.

There is the pensioner who borrowed £500 15 years ago, and still owes £2,000 on the debt. There is the man with learning difficulties who could not understand the forms he signed. One disabled man came into a little money when his mother died. The money brought friends, but when the money ran out, the "friends" walked away and he ran up a £28,000 debt phoning chatlines to have someone to talk to.

Davison has been helping people find their way through problems such as these for 30 years now. Her office, with two filing cabinets of debt cases, has three bookshelves covered in thank-you notes from clients.

The government is keen to promote churches and mosques as delivery mechanisms for social services. Yesterday Lady Warsi, the faith minister, announced another initiative to make small funds available to multi-faith projects, and welcomed a survey showing that the hours donated by schurch volunteers have risen by 36% in the recession, that each church in the country delivers an average of eight social initiatives, and that three quarters of these projects were self-funding.

Thinktanks have popularised these ideas: most recently, the secular Demos, in a report on Faithful Providers, while church-based bodies such as Phillip Blond's ResPublica are exploring developments of this idea. Iain Duncan Smith's Centre for Social Justice has been pushing the role of voluntary organisations since at least 2007. The Church Urban Fund reported that one in 10 Anglican parishes offer organised help with debt and homelessness, and about a third of them offer informal help; only 3% offered organised help with benefit dependency.

Some church leaders are suspicious of being recruited to prop up the welfare state. The bishop of Leicester, the Rt Rev Tim Stevens, told the House of Lords : "I fear that we are heading in the direction of a US-style welfare system, where healthcare provision and pensions are large and protected but working-age provision is less generous and more stigmatised, barely providing enough for people to live on without relying on charitable handouts, where visits to the food bank are not an emergency response to an economic crisis but an integral part of the welfare state."

The delivery of faith-based welfare comes down to little rooms such as Davison's, housed in an abandoned bank building in a small row of shops on a street that once had three thriving churches.

The community centre where she works was opened by a bishop, and about half the board of management are Christians. But very little is funded by the churches. Although Durham is one of the dioceses most heavily funded by the rest of the Church of England – it gets £2m a year from the church commissioners – little of the money trickles down to these projects. Most goes on making up the shortfall in clergy salaries.

Money is tight all round. Davison says : "It's 50 times worse than 10 years ago. It's not just people who are unemployed. We're starting to get middle-class people in. People who through no fault of their own have lost their job and their partnership's broken up. But in the main it's people who are unemployed or on the minimum wage."

But she predicts a multitude of further problems from government plans to cut housing benefit for families in social housing who are judged to have too many bedrooms, and separate moves to make the lowest-paid pay council tax for the first time.

"People never paid council tax in their lives and are living in a two bedroom, apartment," says Davison. "All of a sudden they are going to be paying council tax, and then on top of that they are going to be hit with the bedroom tax. All of a sudden they are going to have to find, out of about £70 a week, an extra £10. Where are they going to get that from? I'm frightened, to be quite honest."

The only thing that the new archbishop of Canterbury, Justin Welby, has denounced as "evil" during his time as the local bishop is loan sharking.

"The bishop of Durham had his head in his hands when he come here. He had his head in his hands on that table and he just said, 'Oh God''. He was quite disgusted with what was going on," says Davison. Last year, she was diagnosed with cancer, and her work was taken over by her assistant, Mandy Allcock, who does 16 hours a week on minimum wage. When Davison's treatment was over, she got a handwritten card from the bishop: "'Wonderful news!' it said. Alleluia and all that sort of thing."

Down the coast, in Sunderland Minster, the first thing to greet a visitor is a notice board asking for contributions to a food bank and a night shelter. The canon here, Sheila Bamber, was once a rent collector, working door to door in social housing in Hartlepool.

But now she believes she can be far more use in the church than in the welfare system.

"I can say more things in more places. The reach of this church is enormous, much greater than the congregation. We have 5,000 worshippers and maybe five times as many people passing through in a year," says Bamber.

Graham Wharton, from the Salvation Army, works closely with her on the food bank and night shelter projects. "We don't have a political agenda. But there has been a massive increase in people knocking at church doors," he says. "We get a lot of referrals from professionals whose statutory methods have failed. Often we can say, 'We can't fix this, but we know this person who can help.'"

For Wharton, one of the great services the church can provide is simply a sense of worth. People come to them convinced they are hopeless: "They say, 'I cannot provide for my family what they're used to. I am a failure as a human being.'"

It is impossible to get away from questions of morality when talking about faith-based welfare. There are certainly stories of greed and stupidity as well as desperate need among the people who get themselves into trouble with debt.

Bamber remembers from her time as a housing officer one of the three evictions she carried out. "This was in the 80s and they had bought themselves a video player. They were eating McVitie's chocolate digestive biscuits. In my house, we only had chocolate digestives at Christmas."

So she is sympathetic to the argument that some people are led astray by consumerism. Time she spent as a theological student in India showed her how little some people can be content with. "We need to get back to what we need to be really alive, and not blind ourselves with consumerism. But people dropping out of the system now are doing so to a level of basic need," says Bamber.

The Sunderland Minster hands out food, but not money and arranges shelter rather than vouchers, to avoid producing tradable commodities. But the idea that the church workers are morally superior to their clients is one Bamber emphatically rejects.

"All of us need to be changed morally from the inside and I don't have a monopoly on any of that stuff and neither does the church," she says.

What Christians can do, she believes, is neither to preach nor to feel smug, but to try to live in a more hopeful and less selfish way than the world around them. "We might hope that we might model a community of people who hold principles that will show you different ways. There's a lot of truth in 'there but for the grace of God'."

Wharton worked as a retail banker until he was 40, helping to create the problems he now tries to clear up. He's much more willing to testify about his faith, if asked, but he is not in the least bit triumphalist.

"The loan shark is more entrenched and rooted in the community than the church is. He's a friend. If I need £10 to put food on the table, I have a friend. What do we have to offer them instead?"