This Worries Us Most About China, Says World Bank

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Financial instability in China, stemming from its vast shadow banking sector, is a lurking threat for the world's second largest economy, according to Hans Timmer, director of the Development Prospects Group at the World Bank.

"[China has] a shadow banking sector where nobody knows who is on the hook for all kinds of loans; [it] has 160 percent of GDP [gross domestic product] of private sector debt, and there are a lot of vulnerabilities there," Timmer told CNBC on Tuesday.

This weekend, ratings agency Fitch Ratings warned that the scale of credit in the economy was so extreme that it would find it difficult to grow its way out of the excesses, The Daily Telegraph reported.

(Read More: How China Could Douse Optimism From the Fed)

The main concern regarding the shadow banking sector - which is estimated at $5.86 trillion or 69 percent of GDP, according to JPMorgan – is the lack of transparency in where the money is going or who is lending - unlike the mainstream, regulated banking sector.

Timmer, however, said he is taking comfort from the fact that mainland policymakers are aware of these problems and are trying to address them.

In the recent months, the government has stepped up efforts to rein in lending outside traditional channels. In February, for example, the Financial Times reported that the government will require banks to provide greater disclosure about their off-balance sheet activities.

(Read More Chinese Officials Even More Pessimistic on Local Debt)

Discussing his growth outlook for China, he said that policymakers are "serious in guiding the economy to a lower growth path," as they rebalance the economy from being export-led to domestically driven.

"They are not packing when they see a month of relatively poor export performance," he said.

Last week, the World Bank downgraded its 2013 growth projection for China to 7.7 percent from 8.4 percent.

(Read More: Now, China Watchers See Growth Below 7%)

"They [policymakers] have the target of 7.5 percent - they take that seriously, and they understand when you look ahead a decade or longer, growth will be in the range of 6 percent," he said.

By CNBC's Ansuya Harjani