It appeared to be a case of game set and match in the City tonight after Downing Street admitted it had backed away from a confrontation over bank bonuses.

Despite the first item on the coalition's agenda for government being a crackdown on unacceptable bonuses, the Conservative-Liberal Democrat administration said it was not going to "set bonus pools for individual banks".

When Bob Diamond, the new chief executive of Barclays, gives evidence to the Treasury select committee tomorrow he does so safe in the knowledge that ministers will now heed the demand from the prime minister to stop "bashing bankers".

One senior banking source said : "All the banks have known for some time that as long as we do the necessary things – being prepared to lend and not saying anything silly – then the government wants us go ahead and be successful."

The irony of the government's climbdown was not lost on the former chancellor Alistair Darling. Castigated while he was in No 11 by the opposition parties for an alleged failure to tackle bank bonuses, Darling said today: "The government has made a lot of noise but it hasn't actually done anything. They are increasingly seen as empty vessels."

In opposition there had been no bigger scourge of bankers than George Osborne. Vying with Vince Cable for the politician who could be toughest on the City, the then-shadow chancellor said in the autumn of 2009 that no high street bank should pay a bonus of more than £2,000 in cash.

Even this was a slight softening of Osborne's rhetoric a few months earlier when he said it was "totally unacceptable" for bonuses to be paid while the government was guaranteeing the banking system. "It must stop," he told the Guardian in August 2009.

In government, it has been a different story. The tough approach to banks lasted until the formation of the coalition in May, but the retreat began almost at once. Rather than put Cable, the Liberal Democrat who found his voice attacking the banks before and during the 2008 financial crisis, in charge of reforming the banks, Osborne insisted he have the final say.

In so doing, he ensured that the Treasury – institutionally and instinctively wary of cracking down on the City – was at the centre of the coalition's approach to reform. In the days before Christmas, the deputy prime minister, Nick Clegg, had been keeping up the pressure. He told the Financial Times that "banks should not be under any illusion that government cannot stand idly". But earlier today Clegg had begun to water down his views, telling Radio 4's Today the banks should be "sensitive" to public concerns.

The government was still insisting tonight that it has imposed the £2.5bn a year banking levy that would help to bring the record deficit down. A spokesman added: "The government wants to see a smaller bonus pool this year than last year and expects the support of the banking industry in delivering this."

Cable and Osborne are preparing to summon the banks to another meeting at the end of the month, just as they prepare to report their 2010 profits and bonuses. Sources caution there could still be a last-minute decision to take tough action on bonuses. But while there will be demands for banks to lend and pressure to provide information on the pay of their five highest paid staff – currently a secret – around the boardrooms of Britain's leading banks, this will be seen as a small concession given how terrified they were at the prospect of Cable breaking them up and clamping down on their earnings.

A number of factors have acted in the banks' favour. Firstly the suspicion in the City of the commitment of the Conservatives – heavily dependent on financial support from the Square Mile – for a stand-up fight. Second, the threat of the banks moving their operations out of London to the fast-growing financial centres of east Asia. Finally, the politician most likely to take the fight to the banks – Cable – is a diminished figure after being stripped of the powers to intervene in the takeover of BSkyB by its majority owner, News Corporation.

The Lib Dems, though, are trying to keep up the pressure. A Treasury spokesman, Lord Oakeshott, said: "We want disclosure of anyone earning more than the top civil servant and no bonuses for chief executives whose banks aren't meeting their lending targets".

For the government this may be a lesson of how the loose talk of opposition becomes tempered by the reality of power. But when the bonuses are paid out at time when most families are struggling with rising prices and squeezed incomes, the political price could be a high one. David Hillman, spokesman for the Robin Hood Tax campaign on transactions, said: "It's time the government woke up to public anger and made banks pay to repair the damage they've done to our economy."

Darling said the government's climbdown, "doesn't match all the tough talk they were coming up with even at the end of last year".

He added: "I've never been in favour of banker bashing but the case for restraint is as strong this year as it was last year. The banks are not out of the woods and they are still dependent on government support. They need to realise many people are taking a wage cut and they need to realise they live in the same world as everyone else."