> Search through your file system by guessing the common file paths for password folders, etc, effectively being able to upload your whole file system to its servers, given enough time.
Sure can.
> Could it modify local files? Could it delete local files?
No. The file access checkbox grants only readonly access. There's no way for an extension to write files through this. There are other ways but they require installing a separate external app (nativeMessaging) or confirming the access interactively (File System Access API).
The "Read and modify all your data on all websites" permission allows extensions to change data inside the tab/frame that shows the site and make a network request to the site, which may be processed by the server and change the remote data as a result. Since file:// protocol isn't served through a server the extensions can't change data on such URLs.
> I think Chromium should implement a warning when toggling this option, because many people assume that this toggle would only give read permission for the files the user opens inside the browser.
+1 and the warning should be always shown under the switch and this switch should be even in red color.