I think Bruce does have a point regarding how a Sensei can judge a persons character from limited contact in a Dojo setting. Thats probably why we read about traditional Senseies requiring letters of recommendations for new students. I think even O'Sensei did that for students too.
I think a Sensei will get an idea of a students character after a while. Eventually they will see how they interact with other students, react to training difficulties and if talked to maybe even learn some of the students outlook on life.
It won't be perfect and as I said before I think it will be more of a case of not promoting someone if the Sensei feels they have poor character. As well it should likely only become a bigger factor at Yudanhsa levels at which time it is very likely the Sensei has come to know that student well.
In any event I don't believe technical skill should be the sole criteria for continuing promotion.