The heated competition between the banking and securities industries threatens to become an all-out war following a proposal this week by the Federal Deposit Insurance Corp. that state chartered banks be allowed to underwrite stocks and bonds.

Reaction within the brokerage community was swift and strong to what is considered the most serious challenge in 50 years to the Glass-Steagall Act, which separates commercial from investment banking.

FDIC Chairman William Isaac "is saying to hell with it," declared Don Crawford, senior vice president of the Securities Industry Association. He termed the FDIC's action "outrageous" and indicated that the SIA would sue if the proposed change is made.

Calling the FDIC's proposal "statutory book-burning," David Silver, president of the Investment Company Institute, the trade group for mutual funds, said he would be "surprised if even the most ardent proponent of deregulation in Congress would approve of this extremist repeal of the act." ICI is already suing the FDIC over a similar issue.

Sen. Jake Garn (R-Utah), chairman of the Senate Banking Committee, issued a statement saying the issue was bigger than state banks' powers. "It goes to the basic structure of our financial system" and should be decided by Congress in the context of the entire system, he said.

Isaac, considered the financial regulator who advocates the quickest and most radical deregulation, proposes to utilize a loophole in Glass-Steagall that would permit state-chartered banks--but not those federally chartered, to underwrite securities. More than half of all U.S. commercial banks hold state charters and are not members of the Federal Reserve System.

Were such a proposal adopted, some observers say, there will be a rash of switches by big banks from federal to state charters and the wholesale purchase of state banks by securities firms.

The proposal also widens the wedge between the FDIC and the Fed, which opposes banks underwriting securities because of fears of adverse effects on the banks' soundness and on the monetary system.

Anticipating objections, the FDIC built in some precautions. Banks would be allowed to underwrite only through subsidiaries and then only money market-type mutual funds, top-rated debt securities, and securities on a "best efforts" basis. The latter category refers to situations when the underwriter tries hard to sell the issue but does not agree to purchase any unsold securities for his own account.

This latest blow to the securities industry came on the heels of a victory for the money market funds. Earlier this week, the Comptroller of the Currency warned national banks against misleading the public in their advertisements for money market deposit accounts, which compete with the money market funds. Comptroller C.T. Conover said banks must state how long the advertised rates will be in effect and whether service charges are imposed. Violators could face fines of up to $100 a day.

Thanks to a recent change by the Securities and Exchange Commission in the type of advertising permitted money market funds, they are now operating under virtually the same rules as the money market deposit accounts.

Silver said that Individual Retirement Accounts placed in mutual funds have increased to $5.9 billion, or about 13 percent of all IRA sales, since January 1982.

Also, first quarter 1983 net sales of all types of mutual funds other than money market funds reached a record $6.5 billion, or five times greater than a year earlier.