Importance of Magento Config xml

The config is the beating heart of the Magento System. It describes, in whole, almost any module, model, class, template, etc. than you'll need to access. It's a level of abstraction that most PHP developers aren't used to working with, and while it adds development time in the form of confusion and head scratching, it also allows you an unprecedented amount of flexibility as far as overriding default system behaviors go.

Path of magento config xml
app -> etc -> config.xml

The other one is local.xml at the same place, it store the database access setting.