Dear Key:
I'm a professor of the guitar department in University, thus testing is a fundamental part of my job there. In the last years, I did try a lot of possibilities: exam, recital, papers, lectures. Now, I dismissed all but one: recital. I think that it is the real aim of any serious music study, and so I want my students to play their repertory in the end of each semester. Of course, there are distinct requisites. Freshmen usually share a recital, each one playing 15-20 minutes of music; the diploma semester requires a full lenght recital, at least 60 minutes.
Although the practice in another situations is different, I find great results applying the same procedure to my other activity, teacher in a private school. Of course, the way you can do that must change, since the student in a school don't have an obligation of do an exam or recital, but most want to, as yours told you.
About the exams, I'm really against them. I think it's a very useless situation, that have nothing to do with the core of musical art. What is the point in asking a student to play a selection of unordered parts of pieces to an audience made of three, all with scores in their hands? It is an orthodoxy that we must walk away, because it proves nothing but you can play in an exam. A recital is just another story, and there the musician can show what s/he's made of.
Best wishes!