In the admin's shoes, I would post again to say "I've asked you to take this conversation elsewhere. Any continued discussion will result in temporary bans" and then start the bans from that point onwards. I think a secondary warning that banning is imminent is probably fair.
Of course, there's a secondary question which is "Should the admin have asked them to take it elsewhere in the first place?", which is more controversial:
Transcript 1.1Person A: Prayer will help your go
Person B: In my last game, I didn't have a prayer

Person C: Assuming of course that god exists
Person B: The hand of god was scratching his nose
...
In this situation, what should the admin do, if anything? There are a number of issues:
Are discussions mentioning anything related to religious material forbidden? Does satire count? Is the spirit of any restrictions regarding religious discussion aimed towards preventing inflammatory arguments and possible religionism type comments and offence, or discussion of any form of God/belief system in its entirety? Should the admin turn a blind eye if it remains harmless and well-natured? Should the admin exercise his or her discretion regardless of the state of the conversation? Should the admin use historical similarities to other similar conversations to make his judgement? Should the admin use historical knowledge of the people involved to make his judgement?
None of these are clear cut questions with clear cut answers, and a difference in opinion of how each should be handled is, I suspect, a large part of the issues surrounding the KGS administration.